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Property investment: The right loan makes a differenceThe right loan is about more than just interest rate and features. Speak with an expert
The astute investor also needs to consider the tax and cash flow implications of their loan product.
Interest paid on a loan is tax deductible, but the principal repayments are not. Many investors opt for interest only loans because:
- the loan repayments are smaller; and
- the loan repayments are fully deductible.
The comparison is more clear when you compare the after tax cash flow (see below). The difference of $7,000 can be the difference between being able to afford a property or not.
|Interest Only||Principal & Interest|
* first year of loan ** assume 31.5% rate
If an investor has a home loan in addition to their investment loan they should pay off the home loan first. This is because the investment loan is tax deductible and a percentage of the interest paid is refunded on your tax return. For example, if your marginal tax rate is 30% then a tax deductible loan is effectively 30% cheaper than a non deductible loan.
To maximise the tax advantage an investor should:
- pay the home loan as principal & interest
- pay the investment loan as interest only
Investors should avoid using their investment loan for any non-investment purposes. It sounds simple, but failure to do this can create a tax mess.
The reason is that the tax deductibility of loan interest depends on the use of the loan. If only 90% of the loan funds are used for your investment, then you can only claim a deduction for 90% of the interest.
For example, an investor has an investment loan of $225,000 and redraws $25,000 to buy a new car. The loan is now only 90% deductible ($225,000/ $250,000) and the interest calculation can become very complicated.
You can re-draw the loan for property related expenses without affecting the deductibility of the loan, e.g. to pay for property related expenses, repairs or improvements.