The banks are addicted to mortgage loan writing and the selling of assets. But the fear of further interest rate rises and a sharp drop in applications for investment property loans. This has forced the banks to offer some of the best fixed rate deals ever for property investors who can pay the interest on their loan annually in advance.
The banks are offering such customers discounts of up to 30 basis points on their standard fixed-rate home loans in the lead-up to the end of the financial year.
For example, NAB is offering a fixed rate of 7.14 per cent on its Tailored Home Loan for terms of one to five years, where interest is paid annually in advance. This compares with a rate of 7.44 per cent for its standard fixed rate product and the average standard variable rate of 8.07 per cent.
Warren Shaw, NAB’s regional general manager mortgages, says the bank is currently offering its largest ever discount on prepaid interest, fixed rate loans. June is traditionally an “on sale” month for this type of investment loan but Shaw says the discount is usually 10-15 basis points, not 30 basis points.
The value of investment loans slumped by 5 per cent in March, the largest fall in five months, according to the latest figures from the Australian Bureau of Statistics.
But it seems the uncertainty about interest rates has prompted more borrowers to opt for fixed-rate loans. Figures compiled by Mortgage Choice show fixed rate loans accounted for 34 per cent of housing loan approvals in April, up from 30 per cent in March.
Denis Orrock of InfoChoice says competition between the banks is especially aggressive as they target a shrinking pool of property investors. The discounts go from 30 basis points at NAB and ANZ to 1 basis point at BankWest.
The ability to pre-pay interest is appealing to property investors, rather than owner-occupiers, because only investors are able to claim a tax deduction for interest payments on their loan as well as other costs (see box).
By paying 12 months interest in advance, investors can claim the deduction this financial year, rather than wait 12 months for the tax benefit.
Shaw says the strategy is especially appealing this year because of the tax cuts announced in the recent budget, which come into force on July 1. It makes sense to bring forward deductions to a year when you are liable to pay more tax.
“I suspect we’ll see the same thing [heavy discounting] next year,” says Shaw (the second round of budget tax cuts come into force on July 1, 2008).
Lenders typically offer fixed rates for loan terms of between one and five years, although three years is the most popular.
Rates may vary for different terms but at present long and short-term rates are similar. NAB offers a flat 7.14 per cent across the board on its fixed rate interest upfront products while ANZ, for example, offers 7.15 per cent on terms of 1-3 years and 7.25 per cent for its five-year fixed product.
The discounted rates are attractive but the ability to pre-pay interest is only suited to individuals with the cash flow to take advantage of the offer, not just this year but each year for the term of the loan.
Twelve months’ interest on a $250,000 loan would amount to $17,850. This is a significant amount of cash to have on hand and, as Orrock points out, while the full amount is tax deductible, the amount you get back is determined by your marginal rate. Hence, someone on the top rate of 46.5 per cent who paid $17,850 interest in advance and claimed it as a tax deduction would get back $8300 through the tax system but still pay out $9550.
Keiran Canavan, the head of private client services at Centric Wealth, says investors need to ask themselves if the strategy will be ongoing and for how long.
“They may decide to fix a rate for a year and renegotiate the rate again next year,” he says. But if you think rates are likely to go up in the next 12 months and you know you will have the ability to pre-pay interest on an annual basis for a number of years, it may pay to fix your rate for longer.
Orrock says investors who take out an interest-in-advance loan only to find they haven’t got the cash to pay upfront in subsequent years would be forced to refinance and could incur switching fees and break costs.
Ideally, Shaw says investors should start thinking about structuring their affairs after Easter, rather than leaving it to June. Simply re-fixing an existing loan can take as little as half an hour but new customers should allow ample time to have their application processed.
Canavan says a lot of clients miss the cut-off date. However, a good adviser can make arrangements with the lender to have the loan drawn down in time to allow pre-payment of interest by June 30.
What you can claim
If you own an investment property, you may be able to claim a tax deduction for a raft of expenses in addition to the interest on your loan.
Ali Noroozi, a tax counsel for the Institute of Chartered Accountants of Australia, says when landlords claim body corporate fees, they should make sure they don’t include contributions to sinking funds, which can’t be claimed as a deduction. Noroozi also reminds landlords that items such as fridges and washing machines can’t be claimed as an upfront deduction but must be depreciated over a number of years.
Depreciation can be claimed for items such as freestanding furniture, whitegoods and TV. You can claim the full amount of items costing $300 or less in year one.
You may also be able to claim a capital works deduction for constructions costs such as improvements to driveways, fences and retaining walls.
Also be aware that if you rent out part of the property or rent it for part of the year, you can claim for only that portion of your expenses.
Source: www.ato.gov.au
