Loan Structure – how to have an efficient one?
If you have a loan – I may be able to show you how to save thousands of dollars in the long run. If you are planning to get one – it could be the perfect time to consider your loan structure. Getting it right early can save money and buy time (a lot of it).
I am a bit of a perfectionist at times and when it comes to reducing waste – I am up for the challenge! One part of the puzzle when you start with property investment is to find the loan structure that works for you. In fact, for some reason I was fascinated by the experiment of how far I can actually push it. My intention was to find a lean way of running my finance and reduce the unnecessary waste such as bank fees, interest and other commissions.
Like a good and simple cooking recipe, here is what it needs:
- Interest only home loan – this is the loan account to deposit home loan repayments. The repayments can consist of principal and interest or interest only amounts, yet from the investment stand point I would like to assume that investors have opted in for interest only repayments.
- Credit card – ideally you need a credit card that allows you to earn points. Usually those credit cards come with a dearer yearly price tag. Some financial institutions however offer it for free as part of the home loan package.
- Offset account – this account is linked with the home loan account. All the funds kept in that account “offset” your home loan balance, hence you are only charged the interest on the difference. For example – if your loan was $500 000 and your offset account had $100 000 worth of funds in it, the interest would only be charged on $400 000. The great benefit of this account is that the account holder has access to the funds at any time, just like he/she would for the savings or cheque accounts.
Too simple you may think? Perhaps, but I believe this is the case when less is actually more!
The following illustration will help you to understand the structure that I am about to explain.
Having the offset account is a central pillar of the above loan structure. This is the key to making your home loan structure efficient. Everything else on the diagram supports the offset account to increase its efficiency.
Since the offset account balance offsets the home loan balance the goal is to keep as much money in it as possible (unless you have a better use for it). Banks calculate the interest on a daily basis, hence every transaction in or out of the account makes a difference. The bottom line is – the sooner the money is deposited into your offset account the less interest you are charged.
To achieve the above – consolidating all income streams is a great solution. This may include salary, rental payments, dividends or any other type of income. If you are currently paying out your home loan (i.e. principal payments) you may want to consider switching to interest only loan. The principal repayments can be made to the offset account instead. This would identically reduce the loan amount the interest is charged on yet you retain the access to your funds.
The use of a credit card makes another important contribution to the overall picture. The benefit is that you get to use bank’s money whilst your money is offsetting the home loan. Most credit cards come with 55 days (check with your bank) interest free period. This means that you can make purchases and repay it later with no interest or penalty. To make it even more hassle-free, you can opt in for automatic monthly repayments in your internet banking.
I use my credit card literally everywhere I can now. I pay for shopping, bills, holidays and other needs and I never pay a cent in interest. It works even better if you have a credit card that awards you points for making purchases. Those points can be later converted into gift cards or cash. To summarise – I have received close to $1000 cash back this year for using my credit card and I have paid no interest on any of my purchases.
- If you have a partner or a spouse you can nominate a secondary credit card holder. This will save you extra credit card annual fees.
- Pay your bills only when they are due. This way you get to keep as much money as you can in your offset account for as long as you can.
- Pay with the American Express credit card instead of Visa or Mastercard. I found that American Express gives you almost twice as many reward points.
- Carrying cash in your pocket costs you money. Instead the money could be sitting in your offset account reducing your home loan interest repayments.
In my view the above loan structure is imperative for property investors as I worked out that it saves me around $5000 a year. If you add a long-term thinking and compounding magic – the difference could be enormous. If you are paying your loan out (i.e principal and interest repayments) – the above approach can save you years.
As with everything – this may not be a perfect setup for everyone as our individual circumstances are always different. Nevertheless, I hope there is a thing or two that you may find useful to improve your bottom line.
I wish you a very successful and happy investing!
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