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Investing & Super / Geared Investments / EOFY / Fixed interest strategies

Introducing James and Elizabeth

  • James and Elizabeth are long-term investors who have been using a Geared Investments Loan for a number of years. They have a $100,000 loan balance, and have always operated their investment loan under a variable interest rate.

Example Strategy 1:

Interest cost certainty by locking in a fixed rate (prepaid interest yearly in advance)

Situation

In more recent times, James and Elizabeth have become rather conscious of interest rates changes. With interest rates and the economic climate being so unclear, they would like to know more about how they can lock in interest cost certainty.

As their cash flow circumstances are also adequate and they have enough surplus cash, they would also prefer to pay their interest payment on their $100,000 loan balance upfront as a lump sum before the end of this financial year.

Solution

James and Elizabeth could fix their interest rate and prepay their interest in advance for a period of as little as one year, or up to five years. 

Outcome

Instead of paying interest monthly in arrears as they are currently, they will pay one year's interest in advance on each anniversary of their fixed loan.

Advantages and Disadvantages

  • Advantages

    • Provides interest rate certainty
    • Interest savings if their fixed interest rate is lower than their average variable interest rate over the fixed term
    • In some circumstances, it may be beneficial for a potential tax deduction to be brought forward to the current financial year (if paid by 30 June)

  • Disadvantages

    • Requires a lump sum interest payment upfront (Note: they may be able to capitalise/borrow this amount so no cash payment would be required)
    • Additional interest costs if their fixed interest rate is higher than the average variable interest rate over the fixed term
    • Break fees may apply if they decide to terminate/break their fixed loan before maturity
    • Potentially higher taxable income in the following year if deduction is brought forward to the current year. This could also lead to higher PAYG tax instalments (i.e. cash flow consequences) in the subsequent year depending on individual facts and circumstances

Example Strategy 2:

Interest cost certainty by locking in a fixed rate (paid monthly in arrears)

Situation

In more recent times, James and Elizabeth have become rather conscious of interest rates changes. With interest rates and the economic climate being so unclear, they would like to know more about how they can lock in interest cost certainty.

They would prefer a repayment frequency similar to their current arrangement on the variable interest rate.  

Solution

A solution for James and Elizabeth could be to fix their interest rate and pay their interest monthly in arrears for a period of as little as one year, or up to five years. 

Outcome

No upfront payment of interest is required, and they will know with certainty the amount of interest they will be required to pay during the period they choose to fix their interest rate.

Advantages and Disadvantages

  • Advantages

    • Interest rate certainty
    • Regular monthly repayments for improved cash flow management
    • Interest savings if their fixed interest rate is lower than their average variable rate over the fixed term

  • Disadvantages

    • Additional interest costs if their fixed interest rate is higher than their average variable interest rate over the fixed term
    • Break fees may apply if they decide to terminate/break their fixed loan before maturity

Example Strategy 3:

Split their loan, and prepay some of their interest costs annually

Situation

James and Elizabeth are keen to pay some of their interest costs in advance, and before the end of the current financial year to bring forward their tax deductions. However, they do not have enough surplus cash to pay the interest in advance on their entire $100,000 loan balance. 

Solution

A Geared Investments Loan provides borrowers the ability to split their current loan balance into any combination of the previous two interest rate options. This could be particularly useful if you want to 'hedge your bets' on interest rate movements, or if you want to reduce the lump sum prepayment required at year-end.

James and Elizabeth's adviser suggests they fix their interest rate and pay in advance the interest costs of $60,000 only. The remaining $40,000 will remain on a variable interest rate, where the interest is paid monthly in arrears.

Outcome

James and Elizabeth enjoy the certainty of a fixed rate and have peace of mind that they have prepaid the interest on $60,000 of their loan balance. They also continue with the flexibility of a variable rate loan on the remaining $40,000 loan balance. 

Advantages and Disadvantages

  • Advantages

    • Greater interest rate certainty
    • Total interest costs may decrease if their variable interest rate falls
    • Interest savings if their fixed interest rate is lower than their average variable interest rate over the fixed term
    • In some circumstances, it may be beneficial for some of the potential tax deduction to be brought forward to the current financial year (if paid by 30 June)

  • Disadvantages

    • Requires a lump sum interest payment (Note: they may be able to capitalise/borrow this amount so no cash payment would be required)
    • Total interest costs may increase if their variable interest rate rises
    • Additional interest costs if their fixed interest rate is higher than their average variable rate over the fixed term
    • Break fees may apply if they decide to terminate/break their fixed loan before maturity
    • Potentially higher taxable income in the following year if some of the deduction is brought forward to the current year. This could also lead to higher PAYG tax instalments (i.e. cash flow consequences) in the subsequent year depending on individual facts and circumstances

Other case studies

View the case studies section

What are the risks involved?

  • Borrowing to invest can multiply your investment returns in a rising market. However, if your investments perform poorly, it can also multiply your investment losses.

    Other risks associated with an investment loan include:

    • Borrowing limits may be reduced, increasing the potential for a Margin Call
    • The variable interest rate may increase resulting in higher interest costs
    • Margin calls may require investments to be sold quickly at unfavourable prices if you are unprepared
    • Tax legislation or marginal tax rates may change

    There are a number of things you can do to reduce the risks associated with an investment loan. For example, borrowing less than the maximum allowed reduces the risk of a margin call.

    Before you apply for an investment loan, you should speak to your financial adviser who will be able to help you put an appropriate strategy in place. Investors should also obtain professional taxation advice that addresses their individual circumstances before taking out an investment loan.

Things you should know

  • The Geared Investments Loan is provided by the Commonwealth Bank of Australia ABN 48 123 123 124 AFSL and ACL 234945 and administered by its wholly owned but non-guaranteed subsidiary Commonwealth Securities Limited ABN 60 067 254 399 AFSL 238814, a market participant of the ASX Limited and Cboe Australia Pty Limited (formerly CHI-X Australia Pty Limited), a clearing participant of ASX Clear Pty Limited and a settlement participant of ASX Settlement Pty Limited. 

    This information contains general advice and has been prepared without taking into account your objectives, financial situation or taxation needs. You should consider its appropriateness, having regard to your objectives, financial situation and needs. Investors should read the relevant disclosure document and seek professional advice before making any decision based on this information. 

    Tax considerations are general, based on present taxation laws, and may be subject to change. You should seek independent, professional tax advice before making any decision based on this information. Commonwealth Bank is not a registered tax (financial) adviser under the Tax Agent Services Act 2009 and you should seek tax advice from a registered tax agent or registered tax (financial) adviser if you intend to rely on this information to satisfy the liabilities or obligations or claim entitlements that arise, or could arise, under a taxation law.

    Important information