March, 2013 - Avoid "Bad" Debt – But "Good" Debt may be OK for you!
It's a common thought that we need to avoid debt, or pay off any debt
we have as fast as possible. That is good, solid, but conservative advice.
Why conservative? Because you may be able to grow
your financial assets faster by using what we call "good" debt. Let's explain
this:
From a financial planning perspective, you would
like to have no debt, but if you do have debt, you really want to ensure that
the interest you pay is tax deductible. Tax deductible interest (interest on
loans for shares, rental properties, and other income producing assets) is good
debt. Interest that you pay on your home loan or personal credit cards or on
personal loans is "bad" debt, because you cannot claim this interest as a tax
deduction.
Most people have a home loan and personal credit
cards, and the interest on credit cards is much higher than for your home
mortgage. That's why financial planners recommend that you use whatever surplus
income you have each week to first pay off your credit cards, and then once you
have done this you can start to make extra repayments towards your home loan.
If your home loan has an interest rate of 6%, then you effectively earn 6% for
every dollar you pay off your home loan.
Here's where debt may be good for you:
If you feel comfortable investing in shares and
you expect a 10% return for the year, you could withdraw an amount from your
home loan (if you have a redraw facility) and invest this in shares. Your share
investment may make a 10% return for the year (dividends received and capital
growth), your interest cost is 6%, and this leaves you with a 4% gain for the
year. So if you invested $100,000 this way, you would make an extra $4,000 per
year after interest costs. Sounds good, doesn't it?
There are always risks with any investment and
please don't take this article as advice to invest – this is something that you
need to talk to one of our qualified financial planners about. The point of
this article is to educate you about the opportunities that you should at least
consider to grow your wealth.
Very Important: You need the right type of loan:
For years we've all seen the TV ads recommending
"Equity" loans – loans that we can redraw against if we need access to funds.
If you want to invest, unless you've fully paid off your house an equity loan
is the WRONG loan to use.
You need to use a "Split" Loan – a loan that has
an overall facility limit but is broken up into 2 different portions, each with
their own monthly statement. The first split is usually for non-tax deductible
debt like your home loan and funds redrawn for private use (eg. if you use some
funds for a holiday).
The second split is for investing. All of the
interest for this second split is tax deductible. If you want to repay any debt
with surplus income, you can simply make payments against the first split and
reducing the balance, but at the same time seeing you are not paying off any
tax deductible debt from the second split, you keep higher tax deductions for interest
from the second split.
Our accounting firm specialises in loan
structuring to ensure your wealth is maximised and your tax is minimised.
Contact us on (02) 4647 4088 if
further information is required.
