A question I'm always asked is "should I be paying interest only or principal and interest on my loans" so I thought I'd share my thoughts. For a lot of SS gurus - this info is nothing new but hopefully some of the new members will gain some benefit from it.
When it comes to claiming an investment loan as a deduction only the interest portion of the loan is tax deductible. The principal portion is not. Therefore, if you have an investment loan, and you decide to pay off some of the principal each repayment, you're effectively reducing this tax deductible debt meaning there is less tax you can claim back.
This can be a costly mistake for those who also have non-deductible debt (which many of us do). This includes a home loan on your Principle Place of Residency (PPOR), car loans, personal loans, credit cards, etc.
If you want to pay down any debt it is this non-deductible debt that you should try and knock on the head first.
So what's the ideal structure?
Whilst there's no "one size fits all" approach to loan structuring - it's generally a good idea to have all of your investment loans set up as interest only.
With your PPOR debt, there are two choices to consider. If you are a disciplined saver and feel that your PPOR may one day be turned into an investment property (and you go onto buy another PPOR), then it's best to also set this loan up as interest only.
However, it's important that an offset account is set up against this loan so you can continue to make the equivalent principal repayments regularly into the offset account. The offset account is also a very handy place for parking any spare savings.
Why is it best to have my PPOR loan as interest only if I think it's going to become an investment property? Because this debt will become deductible in the future so best not to reduce it now.
Instead, you can place your money into the offset account which will reduce your PPOR interest repayments whilst the funds are sitting in the account. When this property becomes an investment property in the future, you can move the funds from your offset account on to your next PPOR. This way, you've increased your tax deductible debt and reduced your non tax deductible debt.
The interest only with an offset account doesn't work very well for someone who isn't a disciplined saver and will be tempted to simply make the minimum interest repayments.
If you're not a disciplined saver and have no desire to convert your PPOR into an investment property at some point, then it's best to have a principal and interest loan on your PPOR. Once you've paid off your PPOR loan and any other non-deductible debt, you may wish to start paying down your investment loans.
So in a nutshell, interest only for all loans with an offset account set-up against your PPOR loan can be a great overall structure particularly if you think you might turn your PPOR into an investment property at some point and purchase another PPOR. On the flipside, if you have no desire to turn your PPOR into an investment property down the track and you are not disciplined with money- then it's best to have interest only against all investment loans and principle and interest against your PPOR.
PLEASE NOTE - this information is of a general nature. Please always consult taxation professionals about the specific nature of your situation.
Cheers
Jamie
When it comes to claiming an investment loan as a deduction only the interest portion of the loan is tax deductible. The principal portion is not. Therefore, if you have an investment loan, and you decide to pay off some of the principal each repayment, you're effectively reducing this tax deductible debt meaning there is less tax you can claim back.
This can be a costly mistake for those who also have non-deductible debt (which many of us do). This includes a home loan on your Principle Place of Residency (PPOR), car loans, personal loans, credit cards, etc.
If you want to pay down any debt it is this non-deductible debt that you should try and knock on the head first.
So what's the ideal structure?
Whilst there's no "one size fits all" approach to loan structuring - it's generally a good idea to have all of your investment loans set up as interest only.
With your PPOR debt, there are two choices to consider. If you are a disciplined saver and feel that your PPOR may one day be turned into an investment property (and you go onto buy another PPOR), then it's best to also set this loan up as interest only.
However, it's important that an offset account is set up against this loan so you can continue to make the equivalent principal repayments regularly into the offset account. The offset account is also a very handy place for parking any spare savings.
Why is it best to have my PPOR loan as interest only if I think it's going to become an investment property? Because this debt will become deductible in the future so best not to reduce it now.
Instead, you can place your money into the offset account which will reduce your PPOR interest repayments whilst the funds are sitting in the account. When this property becomes an investment property in the future, you can move the funds from your offset account on to your next PPOR. This way, you've increased your tax deductible debt and reduced your non tax deductible debt.
The interest only with an offset account doesn't work very well for someone who isn't a disciplined saver and will be tempted to simply make the minimum interest repayments.
If you're not a disciplined saver and have no desire to convert your PPOR into an investment property at some point, then it's best to have a principal and interest loan on your PPOR. Once you've paid off your PPOR loan and any other non-deductible debt, you may wish to start paying down your investment loans.
So in a nutshell, interest only for all loans with an offset account set-up against your PPOR loan can be a great overall structure particularly if you think you might turn your PPOR into an investment property at some point and purchase another PPOR. On the flipside, if you have no desire to turn your PPOR into an investment property down the track and you are not disciplined with money- then it's best to have interest only against all investment loans and principle and interest against your PPOR.
PLEASE NOTE - this information is of a general nature. Please always consult taxation professionals about the specific nature of your situation.
Cheers
Jamie