Unfortunately, debt in most cases is a fact of life. When managed properly however, the right debt now can ensure a profitable investment in the future. Today we discuss how to control and stay on top of your debt in our steps to becoming Financially Well Organised.
Does the bank need all that security?
In today’s society, it is unusual if you do not have some form of debt; home loans, business loans, personal loans, credit cards, store cards. Debt in its various forms brought the world to its knees during the Global Financial Crisis. We referred to it as the Credit Crunch. Meaning debt is here to stay.
A debt plan will help you get control of your finances and make life easier. In order to organise your debt, you need to have a plan that ensures you have the best interest rates on your loans, an action plan to pay off existing debt and you need to consider whether your bank needs all that security.
A Debt Plan ensures:
1. The best interest rates and terms have been negotiated on the loan;
Do I take out a fixed or variable loan? Interest Only or Principal and Interest repayments? Do I take the loan out over 10, 15 or 25 years? There is no one answer to these questions. It is dependant on the personal circumstances of the individual or entity, the current economic conditions, and sometimes what the crystal ball says. But for points 2 and 3 below, there are some very clear strategies that you should consider.
2. A clear action plan has been determined in order to pay the debt off; and
You should ensure that you structure your debt so you pay off your non-deductible debt (the debt you don’t get a tax deduction for) before you start paying off the principal of the loan that you do get a tax deduction for. Sometimes, depending on your personal circumstances, your debt can be structured in a way that it becomes tax deductible.
3. The assets exposed to borrowing are limited and only sufficient to support the borrowing as security.
Only provide the lender with the minimum amount of assets required to obtain the loan. Gone are the days where the bank can dictate that you must provide all of your assets as security in order to receive the loan. You must take the attitude that your loan security structure is not set and forget. Once you can remove assets from what is required as security by the lender, you should.
For example, Henry and Sarah purchase an investment property, which is geared to 100% of the value, and use the equity in their home as further security. Both properties are linked to the investment loan as security and will remain in place until the investment loan is paid off. However, property tends to grow in value over time, and the bank might provide a loan with stand alone security provided so the loan is no more than 80% of the value of the property. This is referred to as the Loan to Value Ratio (LVR). As the property grows in value, the home should be able to be released as security once the LVR limits are reached.
Another example is for business owners. Often they have provided their home as security, which was done in the early days of their business. Their business has grown and acquired assets. The loans in the business can sometimes be secured against the business assets so the home is no longer used as security. If the bank was forced to call up the loan and needed to sell the home to receive the full loan repayment, a significant amount of equity could be lost.
Your Debt Plan Checklist:
- Pay off your non-deductible debt before you pay off your tax deductible debt.
- Only provide the minimum amount of equity required to the bank, and regularly review the LVR’s between the loan and the property value, so assets can be released from the bank’s security.
Let FWO help you develop an effective Debt Plan. Call 07 3833 3999 or email email@example.com today.