Making debt work
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Central to most financial plans is the appropriate structuring of credit where tailoring a client’s loan portfolio can assist with cash flow management, in reducing debt and in saving on interest and / or tax – it can also be a financial tool to build wealth and facilitate a client’s lifestyle.
This article looks at several strategies that when used in combination with your client’s advice will make their debt work more effectively and complement strategies to achieve their financial independence.
A home loan rate is potentially the lowest form of interest your clients will pay. Credit card and personal loans can have rates up to 4 times higher. If a client has personal debts you may want to consider consolidating them into their mortgage. Essentially, they increase the mortgage on their home (assuming there is equity) and use the extra funds to pay off the personal or credit card debts. The overall effect being the lower mortgage rate will apply to all their debts, and by making the same level of overall loan repayments they decrease the length of the loan.
If the value of a client’s property has increased then refinancing can unlock this equity. They can use these funds in several ways, including as a deposit on an investment property, to renovate their home, to upgrade the family car, to assist with children’s education, or for personal investments in a business or in stocks and shares as a part of their wealth creation strategy.
Client circumstances change, interest rates change and mortgage products become superseded and outdated. Through regular review of any existing loan facilities, your clients can potentially secure a better interest rate and reduce their repayments and build equity and take advantage of more flexible terms and features that may be more appropriate for their current situation or that were not available when they originally took out their loan.
If a client has a large amount of cash in a savings account it may be these funds can be used more effectively by transferring them (leaving emergency funds aside) into an offset account linked to their mortgage. This will reduce the balance your client’s interest is calculated on and earn them a higher after-tax return than if in a cash account. Additionally, if they keep repayments at the same levels they can reduce the term of their loan. However, if the offset account is linked to an investment loan it may be more tax effective to have the funds sitting in the offset account so as not to impact the tax deductibility of the interest if these funds are redrawn.
Through a limited recourse borrowing arrangement (LRBA) clients can purchase real property through their SMSF. This can be a residential investment property or for the self-employed and small business owners a commercial investment property where the SMSF is the owner of the premises and the business is the tenant paying a market rent to the SMSF.
If your client is spending less than they earn, a consideration may be to use this surplus cashflow to accelerate the repayment of their home loan. The benefits of this are to reduce the loan term, save on interest and potentially create equity that could be used for other purposes. Simple structural changes such as increasing repayment frequency, increasing repayment amount or crediting their salary to an offset account can reduce your client’s inefficient debt more quickly.
With the right strategy, borrowing money to make an investment can enable your clients to build their wealth faster than if using their own capital. To be successful, the investments acquired with the borrowed funds must generate a total return (income and capital growth) greater than the after-tax costs of financing the investment – including the interest. This is commonly used for property and shares through borrowing against the equity in their home or margin lending.
With the right investment strategy debt recycling can be used to help your clients build their longer-term wealth, whereby the equity in their home is used to establish an investment loan, and these funds are used as a part of their investment strategy. The investment income earnt is then used to reduce the outstanding home loan balance and create more equity to purchase additional investments.
If a client receives a financial windfall they can use this to reduce their home loan debt and borrow an equivalent amount for investment purposes – effectively replacing inefficient debt with efficient debt and establishing part of their investment portfolio and wealth creation strategy.
If your client is currently on a low-doc loan it is likely they will be paying a higher interest rate. If their employment and finances have become more stable it may be an opportunity for them to switch to a full-doc loan, where there may be a lower interest rate, lower ongoing fees or more flexibility.
While these strategies need to be considered in the context of a client’s overall advice and strategy, with the right processes to identify the opportunities and the right broker alliance to implement the opportunities, practices can add significant value to their clients in helping them achieve their financial goals and objectives.
If you need further support or advice, Equilibria Finance can guide you through this process.
Anthony Landahl | Equilibria Finance
This is for general information purposes only and does not constitute advice. With all of these options there are a number of considerations outside the scope of what is covered in this article that you need to understand to ensure your personal circumstances are taken into consideration.
