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Fixed rate interest in advance home loans

Pay the interest on your home loan in advance and look forward to the possibility of tax savings.

An interest in advance home loan is usually an interest-only home loan with a fixed rate, which allows the borrower to prepay interest for the year ahead. By doing this they can obtain tax benefits and often, the lender will offer a discounted rate. Here's how it works and how much you can save.

How does a fixed rate interest in advance home loan work?

As an investor, it may be suitable to take out a home loan that allows you to pay interest in advance on your investment home loan.

With these loans, you usually pay the interest for the year ahead in advance. For instance, in June 2022, you might pre-pay the interest that will apply on your home loan for the next 12 months, meaning you've paid interest in advance until 30 June 2023. This means you can claim the tax deduction in the 2022 financial year.

If you made a capital gain that financial year (for instance, you sold an investment property for a net profit of $100,000), pre-paying $20,000 worth of investment loan interest could help offset the capital gains tax payable. Instead of being charged CGT on $100,000, you'll only be charged on $80,000.

Some lenders also offer discounted interest rates to borrowers who pay their interest in advance as an incentive. For example, Westpac currently offers a 0.20% p.a. discount for interest only in advance home loans.

On an investment loan worth $600,000, this discount is worth $1,200 per year.

Note that this type of arrangement is only allowed on:

George's investment loan savings

George is looking for a fixed rate interest-only investment loan to buy an investment property. He was going to apply for a 5-year fixed rate home loan at 3.5%, until a co-worker told him he could save some money and obtain tax benefits, if he could afford to repay the interest on his loan in advance.

He was in a position to pay interest in advance, so he found a home loan with a discounted interest in advance offer of just 3.3%. Based on a loan amount of $600,000, he saved $1,200 instantly by paying the interest in advance. Because he paid all of his interest at once, he was also able to make an immediate tax deduction in this financial year.

How to compare fixed rate interest in advance home loans

  • Interest rate. Look for loans that offer interest rate discounts to borrowers who do this. Keep in mind that the advertised rate will not take into account the fees the home loan will charge, so add this to your comparison.
  • Fixed rate period. The fixed rate period a home loan attracts usually varies between 1 and 5 years, although fixed terms can go as long as 10 years. At the end of this period, the loan starts attracting a standard variable rate unless you choose another fixed period.
  • Interest-only period. These types of repayments generally only last for up to 5 years with each lender, as they want you to start making payments on the principal eventually.
  • Features. Fixed rate loans usually don't allow extra repayments beyond around $10,000-15,000 a year (without charging a penalty), and very few fixed rate loans come with linked offset accounts. If these features are important to you, this might not be your best option.
  • Repayment flexibility. When you pay the interest that your home loan attracts in advance, you have little in terms of repayment flexibility, because you make a lump sum payment on your interest.

What happens if you wish to sell or refinance?

As with other fixed rate loans, if you repay the loan early for any reason (including refinancing and selling the property), you may have to pay break fees.

Also, you should be able to get a refund on some of the interest that you have pre-paid, pro-rata based on the period of the loan that you repay early.


Pros and cons of a fixed rate interest in advance home loan

Pros

  • Save on interest. If you get a home loan that allows you to make interest repayments in advance, you can usually look forward to a discounted interest rate, and this enables you to save how much you pay in the form of interest.
  • Make lump sum payments. Because these loans are generally interest-only home loans, you don't have to worry about making weekly, fortnightly, or monthly repayments. You simply make one payment to pay your interest costs for the year.
  • Decide if you wish to continue. When the first year comes to a close, you get to choose if you want to continue with the same for the next year, and you get to do this until the fixed rate period or interest-only period comes to a close as well.

Cons

  • Not many features. Most loans that give you the ability to make advance repayments of interest fall short on offering other features. As a result, if you're looking for such a loan, but want a range of features as well, you might find it very hard to find a suitable alternative.
  • Inflexible loan type. This only applies on interest-only, fixed rate investment loans, so it suits a very specific type of borrower.

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