“A bank is a place that will lend you money
if you can prove you don’t need it.”
Get on the top of your loans – smart ways to utilise your liabilities
Generally there are three types of loans:
Loans for personal consumption
Personal loans, credit cards. They tend to be overused but provide the least of the benefit. They are convenient, with a much greater interest rate payable if not paid by due date.
Necessary evil if you wish to own a family home. Fortunately interest charged on home loans is lower in comparison to most other types of loans, and especially when comparing to personal loans and credit cards.
This is what in financial word is called a “good loan”. Established primarily in order to build an asset that will grow in value over time and provide an income along the way, such as a property rental, share dividends or managed fund income distribution. It is called a “good loan” because the loan interest becomes tax deductible for the borrower.
We tend to be over-confident in our ability to repay the debt and often underestimate the likelihood of things going wrong.
Surprisingly one of the main reasons for a mortgage stress (problems with repayments) is not a relationship breakdown (that’s what I thought), but a loss or reduction of income either due to a job loss, an injury or disability. It surprises me, as there is no insurance for a marriage survival, but most certainly there is an insurance policy that will replace your income should you get sick, be injured or become partially or fully disable.
But there are smart ways to reduce mortgage stress:
This is where we can combine all your loans under one home loan roof and pay the lower interest rate for the whole balance. Your outcome will be saving on interest and paying off debts sooner, while the stress has been removed and you could enjoy a better lifestyle.
Budget, budget, budget
I feel like an old record player that got stuck at this point, but especially if things are very tough, you need to implement tough changes. It gets easier with each passing day and each repayment made. I promise.
Create an emergency fund (in your offset account if possible).
This will reduce your mortgage stress even further knowing that in case of an emergency, you do not need to go for another credit card.
Credit your full wage to the offset account
This will create a further interest charge reduction.
Change repayments frequency
Change your monthly repayments to fortnightly. You will be surprised what impact this will have on your loan balance over time.
If possible, increase repayment amount
If you have some cash surplus, consider making extra repayments whenever you can. This reduces your loan at a faster rate, consequently allowing you to save on interest and reduce the life of the loan.
Make sure that you have current insurance along the way. View more information about personal insurance planning.
So for now we really only discussed consumption loans and home loans, but the fun really starts when those two are under control and you are ready for the next stage – borrowing to build your financial wealth.
In order to proceed to this next stage safely you need to meet the following requirements:
- Your consumption loans and home loans are under control
- You have an income surplus (cashflow surplus)
- You feel comfortable in extending your loan for investment purposes
- You are prepared to take an additional risk
- You have sufficient investment time-frame to “ride out” possible market fluctuations
- You have adequate personal insurances in place.
Types of investment loans to consider:
- Home equity
- Margin Loan
Both loans have their benefits and traps and before you proceed with either, please ensure you receive a professional advice. This could be a great way of improving your wealth building strategy, but you need to understand all implications and risks.
This strategy will also involve a great deal of tax planning, to ensure the highest level of the benefit can be achieved.
When speaking with clients who like to invest with borrowed funds we discuss the following:
- What type of mortgage is still current?
- Has it been optimised to its maximum potential?
- What is the equity to loan ratio?
- Income, assets & liabilities – is there an income surplus?
- Is there a suitable “emergency account” in place?
- Is there a suitable insurance in place?
- Has Estate Planning been looked after and how old are legal documents?
- What type of investment are you contemplating?
- Is your risk profile suitable for the borrowing strategy?
- How much can you borrow?
- What options are available for an investment income?
- Is it better to proceed with one large investment or use the dollar averaging strategy, if possible?
- Which type of loan is more appropriate – Home equity loan or Margin Loan? At this point I will explain the difference between the two loans, benefits and disadvantages of each.
- Who should be the owner of the loan?
- Who should be the owner of the investment account?
- What is your Marginal Tax position?
- Do you have any Capital Gains Tax history?
- If investment and borrowing is to be made for a couple even more investigation is necessary.
Borrowing to invest is a great strategy, but it is not for everyone. Crucial factors are usually age, income earned, existing assets, risk profile, years to retirement etc.
Feel free to give me a call to review your current set up or to establish a new strategy. The beauty here is that you can be as inventive and forward thinker as you wish and I can explain options, outcomes, benefits and traps. It is one of the most exciting stages in financial wealth building life.