How to Reduce Non Tax Deductible Debt
Some kinds of debt are more expensive than others because they are not tax deductible. Common types of non deductible debt include: personal loans, credit card debt and car loans.
Typically loans of this sort incur high interest fees and are classified as inefficient debt.
Inefficient debt – Inefficient debts are any loans that require you to use your own wages to service the debt.
Efficient debt – An investment loan on shares, property or any asset that can potentially increase in value and generate income.
The mortgage interest on your PPOR (that’s your Principal Place of Residence) is also classed as an inefficient debt as it is not tax deductible in Australia.
But getting to grips with non deductible debt isn’t that hard!
Here are a couple of ways to reduce non tax deductible debt and the associated costs.
If you have a home loan then it may be a good idea to pay off a range of inefficient debts by consolidating them into your mortgage. Your mortgage will increase but mortgage interest is typically lower than the interest charged for a personal loan or credits cards, so you can make substantial savings in interest.
Things to note:
- Are there any refinancing costs you’ll need to pay to consolidate your loans?
- You need to be able to make the same total loan payments and NOT spend the interest savings (but add them into the mortgage instead), otherwise your mortgage could take a lot longer to pay off and you’ll end up incurring more interest.
Splitting Your PPOR Loan
If you want to reduce non deductible debt on your home loan, plus build long term wealth, then it may be prudent to get your mortgage loan to work harder for you.
When you buy your PPOR, the entire mortgage is non deductible, which is expensive money and inefficient. What you can do is split your PPOR loan and create a new split, full to the brim.
Those funds can then be used for investment purposes (such as buying an investment property or investing in the stock exchange etc).
Say you used the funds to buy an investment property and borrowed 80% for it + brought 25% from this newly created PPOR split (20% payment + 5% purchasing fees) – you just bought a property that is 105% tax deductible!
An interest only period on your investment mortgage will free up funds to pay back your non deductible PPOR mortgage loan split more quickly. You can also claim the interest on the investment mortgage as a deductible expense against your taxable income. Note: many lenders charge higher interest on Interest Only loans so careful planning and consideration is needed.
Another great benefit is that the split is still carrying a low ‘owner occupier’ interest rate as most lenders determine the interest rate by the security (your PPOR) while ATO determines the tax deductibility by the usage (you used the funds to buy an investment property so the interest on the funds drawn is deductible).
This will also increase your borrowing power for future properties as this means your non deductible debt is now much smaller than before.
More options may be available on case to case basis. Get in touch with Ethan today to discuss your personal circumstances and get an expert’s advice!