All Topics / General Property / Question about interest pre-payment

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  • Profile photo of naughtyjnaughtyj
    Join Date: 2011
    Post Count: 17

    Here is a basic question for you financial boffins out there.

    If I have an interest only loan for an IP, I can prepay the next year's interest before June 30 in order to claim it as a tax deduction in the current financial year.

    How does this work with the 'lost opportunity' on the money that I've paid?  Who gets the advantage of the 'lost' interest?

    As a VERY simple example, I have a mortgage of $170,000 and am paying an interest rate of 7.05%

    Prepaying it now means that I outlay $12,000 immediately, but if I were to stick it in the bank at 6% interest and pay it over the next year, I'd be getting interest on the bit that I haven't yet paid:

    ie 12,000 x 1 months interest ($60) plus 11,000 x 1 month interest ($55) plus 10,000 x 1 month interest ($50) plus 9,000 x 1 month interest ($45), etc.

    I know it isn't much in that example, but over the course of a year, could be quiet significant with higher lending amounts.

    Does the bank get all 'extra' interest, or do I somehow get a benefit other than moving the tax liability forward?

    Profile photo of ksherwellksherwell
    Join Date: 2007
    Post Count: 125

    It really depends on your tax situation. Best to talk to your accountant.

    Profile photo of naughtyjnaughtyj
    Join Date: 2011
    Post Count: 17

    Not after financial advice – I'm just curious is all what people's experiences have been (and it's the reason I posted it in the General section of the forum) and if it's the bank that generally benefits by getting the 'extra' interest by holding the money ahead of time.

    Profile photo of Mick CMick C
    Join Date: 2010
    Post Count: 1,099

    Yes you can, it’s called interest in advance. Advantages…
    1. You pay the interest in this financial year ( so if you had an increase in income or bonus etc it would work beautifully) – however next financial year you won’t be able to claim this interest ( so depends when you get a bonus? or sell off a asset with capital gain)

    2. Most banks will offer a discount off their fix rate around 01.-0.2% off if you do interest in advance.

    3. You will need to apply for this by 24th of June 2011 to make it for most of the banks cut off.

    IN affect YOU get the advantage through the tax + lower interest…the banks get the advantage of getting money now to invest into another investment + locking you in for one full year :)


    Mick C | Shape Home Loans
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    Same Banks. Better Rates. Served With a Passion.

    Profile photo of TerrywTerryw
    Join Date: 2001
    Post Count: 16,190

    Banks will usually give a discount for prepaying interest. Usually a massive 0.10%! So it is sort of factored in. But you also have to consider the opportunity cost of not having that money immediately.

    Make sure you don't just plonk 12 months worth of repayments into the loan. You need to organise a special 1 year fixed loan with the bank. Otherwise it will just be a repayment off the principle and you may stil be chased for missed repayments – AND you couldn't claim the interest.

    Also, one more poiint, if you pay next years interest now, then next year you may have little to claim and will have a massive postive income from the property. You may then have to prepay another years interest and be trapped in the cycle.

    Terryw | Structuring Lawyers Pty Ltd / Loan Structuring Pty Ltd
    Email Me

    Lawyer, Mortgage Broker and Tax Advisor (Aust wide)

    Profile photo of naughtyjnaughtyj
    Join Date: 2011
    Post Count: 17

    That's kind of what I was thinking Terryw.

    I'd heard Paul Clitheroe talking about it on the radio and was I wondering about the lost opportunity cost.

    Plus, the point you make about next year being postive income unless you do it again is also something that you'd definitely need to consider before doing so (and obviously talk it through with your financial adviser/accountant).

    Profile photo of v8ghiav8ghia
    Join Date: 2005
    Post Count: 871

    hI naughtyj.
    As mentioned, you will need in most cases the correct loan product – ie an 'interest only in advance loan', which will have a fixed interest rate. By way of illustration, the best of the 'big 4' as far as rates and fees & charges goes currently offer a 20 point discount for their product over a normal 'P&I' loan. You can't just pay the interest off in advance otherwise, or as Terry mentioned you are actually just reducing your loan principal.

    Good for those with a major tax problem I guess.where they won't have one the following year…….

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