What is prepayment of interest and what are it's benefits

Discussion in 'Loans & Mortgage Brokers' started by Chotu, 3rd Jan, 2020.

Join Australia's most dynamic and respected property investment community
  1. Chotu

    Chotu Well-Known Member

    Joined:
    23rd Dec, 2019
    Posts:
    48
    Location:
    Melbourne
    Hi

    Can someone please explain what prepayment of interest is and what it's benefits are? Also any downsides to it? From what i know it can only be done on interest only loans but not sure what tax benefits it has
     
  2. mikel

    mikel Member

    Joined:
    20th Mar, 2019
    Posts:
    23
    Location:
    Melbourne
    We had our investment loan refinanced to fixed interest only and prepaid the interest back in june 19.
    One of the benefit was we able to negotiate a discount of 0.09 and was able to push our interest ahead. given that i had a good contract income on that financial yr, we get a good chunk of tax deduction.
     
  3. The Y-man

    The Y-man Moderator Staff Member

    Joined:
    18th Jun, 2015
    Posts:
    11,412
    Location:
    Melbourne
    Basically in June (this financial year) you pay all of next year's interest ~ so you claim the entire 12 months of the following year's interest in this year's tax return.

    The Y-man
     
    David R Sutantyo likes this.
  4. S.T

    S.T Well-Known Member

    Joined:
    18th Jun, 2015
    Posts:
    624
    Location:
    Melbourne
    Can be handy to offset a capital gain.
     
    lettert likes this.
  5. Fargo

    Fargo Well-Known Member

    Joined:
    23rd Jun, 2015
    Posts:
    1,304
    Location:
    Vic
    Depends on the security For some pre purhcase plans you can pay 3 years interest in advance . The advantage is you can get a low interest rate and a good tax deduction and hopefully a nice lump sum of money or payment in kind on maturity or you may want to let it roll on with another loan. Or you could invest for income from regular coupon payments , effectively reducing tax paid one year and hopefully increasing income during the next 3 years. The higher the tax bracket the lower the risk v reward ratio.
     
  6. Chotu

    Chotu Well-Known Member

    Joined:
    23rd Dec, 2019
    Posts:
    48
    Location:
    Melbourne
    Doesn't it mean that the following year you can't claim any deductions?
     
  7. Cousinit

    Cousinit Well-Known Member

    Joined:
    6th Aug, 2017
    Posts:
    591
    Location:
    Victoria
    I have prepaid a full years interest in late June several times. Hadn't heard of paying three years up front. Certainly worth a thought when rates are so low.

    One of the main benefits to us is the tax deduction and relief on cashflow for a while. The guys at the bank say that this option is not used much at all. Also you need a fixed rate loan I think to be able to do so.
     
  8. mikel

    mikel Member

    Joined:
    20th Mar, 2019
    Posts:
    23
    Location:
    Melbourne
    No, you could still deduct next year on the interest paid for a year ahead.
     
  9. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney

    Joined:
    18th Jun, 2015
    Posts:
    35,863
    Location:
    Australia wide
    Interest would only be deductible if prepay 12 months of less.

    I have never heard of any lender offering 3 years interest in advance.
     
  10. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney

    Joined:
    18th Jun, 2015
    Posts:
    35,863
    Location:
    Australia wide
    prepaying interest allows for the brining forward of expenses which might help where you have a high income this year but a low one next year.

    but you must carefully think this through as if your situation changes you can have hardly any deductions the following year, unless if you prepay 12 months again. It can turn into a vicious cycle.

    Also this requires fixing a loan and it might not be possible to move banks, use an offset account, and rates might drop as well.
     
    lettert and The Y-man like this.
  11. Chotu

    Chotu Well-Known Member

    Joined:
    23rd Dec, 2019
    Posts:
    48
    Location:
    Melbourne
    So does that mean once i get into the cycle, eventually the last year of that cycle I won't have any deductions?
     
  12. The Y-man

    The Y-man Moderator Staff Member

    Joined:
    18th Jun, 2015
    Posts:
    11,412
    Location:
    Melbourne
    Correct. For instance in our case the IO period ended and loan went to PI ~ so we could no longer pay ahead, and there was a year where we had effectively already claimed the interest previous year so no interest deductions.

    The Y-man
     
    Marg4000 likes this.
  13. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney

    Joined:
    18th Jun, 2015
    Posts:
    35,863
    Location:
    Australia wide
    It means you won't have any deductions in one year for interest if you prepay for 1 year.

    example
    Year 1 $20,000 in interest
    year 2 $20,000 interest plus $20,000 from year 3 prepaid = $40,000
    Year 3, $86 interest assuming you don't prepay year 4's interest - you would have a few days of interest only
    year 4 $20,000
     
  14. kaibo

    kaibo Well-Known Member

    Joined:
    30th Jul, 2017
    Posts:
    599
    Location:
    Melbourne
    if you prepay 12 months but after the new financial year starts you move in to live is it pro-rata for tax purpose or the whole amount (unlikely but would like to confirm)?
     
  15. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney

    Joined:
    18th Jun, 2015
    Posts:
    35,863
    Location:
    Australia wide
    You would have to apportion the interest, and amend the previous year's tax return.
     
    kaibo likes this.

It seems that the levelling out of property price rises hasn’t deterred celebrities from investment properties. Nicole has bought her fifth apartment in a complex in Milsons Point in Sydney. This article explains why she may have done that.