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Prepay Your Interest and Minimise Your Tax with Interest in Advance

As the end of financial year approaches, investors start to consider their investment and tax strategies. One strategy available is prepaying interest, known as interest in advance.

Interest in advance is – fixing the interest rate on an investment loan at a discounted rate for 12 months and paying the interest normally incurred throughout the year in one upfront interest payment. Usually made in June of a financial year to ensure the interest deduction is received in the current year.

You will normally receive a discounted interest rate, against standard fixed rates. However, this is not the only advantage of this strategy. Depending on individual circumstances, prepaying interest could also provide other benefits.

Why prepay mortgage interest?

Investors can choose to pay interest in advance for a number of reasons including:

• To assist cash flow and budgeting by utilising a lump sum available at certain times of year (for example a bonus), or simplify finances by making one prepayment of interest upfront rather having to budget regular interest payments throughout the year.
• Locking in a fixed annual rate – protect against possible interest rate rises over the next 12 month period and enjoy a discounted fixed interest rate.
• Immediate tax deductions – a tax deduction for prepaid interest may be available in the year of payment (where certain criteria are met). The benefit of an immediate tax deduction may be even greater where taxable income is higher now than it is expected to be in future years if, for example, there is an expected break from the workforce or change in employment.

Locking in a fixed rate

A key part of paying interest in advance is that a fixed rate will apply. Fixing a mortgage rate means the interest for the next 12 months or up to 5 years is known. Changes in variable interest rates won’t impact the amount of interest payable.

Be aware however that any payout of the fixed rate loan during the fixed rate period may result in a prepayment cost being payable, which can be significant depending upon rates at the time of the payout.

written by:

McKinley Plowman