Breakout costs

[Chromium]

Folks,

I am in a quandry.....

Here is the current situation...

In all my wisdom ( or lack of it ) I fixed my Invt loan @ 9.00%. I acknowledge I made a mistake. But now I feel I am missing on IR drop. (Typical human attitude)

I have a few loans with CBA.

265K PPOR fixed @ 6.74 (maturing May 2009)
260K Invt loan fixed @ 9.00 ...ouch..!!! (maturing June 2011)
61K Line of credit variable @ 5.04....

I checked with CBA and they work out breakout costs for 260K Invt loan to be 28K to go on to a variable of 5.04%.

1. Should I cop it on chin and pay 28K and go on to variable @ 5.04 % (or lesser)
2. If I decide to fork out 28K how can I make it tax advantageous ?
3. Are breakout costs tax deductible ?
4. Is it advisable to increase LOC with another 28K instead and pay for above penalties ?

Any other options that you can think of.

This would make a substantial difference in our cash flow. Rental itself would pay for interest component of holding IP.

 

[Rob Williams]

Welcome to a very big club! You are not alone.
I'm going through the same process. The right answer will differ according to individual circumstances.
My understanding is that the break costs can be amortised over 5 years.
I'd get a huge cash flow advantage by breaking, even after borrowing the $125,000 or so I'd need to break my fixed.
However, in my situation, it reduces my equity and affects my LVR, the result being that my borrowing capacity is reduced. That wouldn't be an issue but for the fact that I'm in the process of trying to finance another purchase.
In my situation, I'll have to forgo the cash flow benefit.
Instead of borrowing to pay "hard dollars" for the break costs today, I'll finance my fixed loans from cash flow in "soft dollars" over the next few years.
I'm not happy about it, but it's the only solution that works in my current situation.
Not sure that helps you at all, but I'm not sure anyone can really help you other than to give you some points of view to throw around and see what resonates with you.
Good luck.

 

[boomtown]

My understanding is that the break costs can be amortised over 5 years.

When you say amortised - do you mean amortised for tax purposes (as a deduction against income) or do you mean the bank will let you pay off break costs over a 5 year period?

 

[Rob Williams]

When you say amortised - do you mean amortised for tax purposes (as a deduction against income) or do you mean the bank will let you pay off break costs over a 5 year period?

Sorry, I meant amortised for tax purposes. Wish it was the other.

 

[boomtown]

I thought it was immediately deductable against income in the year in which it was incurred? Its not a "borrowing expense" which is amortised (because it is an expenditure of a capital nature) but rather is a bank charge (non-capital in nature) which is immediately deductible.

Or am I wrong?

 

[Rob Williams]

I thought it was immediately deductable against income in the year in which it was incurred?

Is it an election to amortise?

I've been told that's not the case. Break costs treated like other loan costs at the front end. Any accountants want to comment?

 

[boomtown]

I think this private ruling is on point:

Deduction for mortgage discharge fees.

Section 25-30 of the Income Tax Assessment Act 1997 (ITAA 1997) states that you can deduct an expenditure that you incur to discharge a mortgage that you gave as security for the repayment of money that you borrowed, if you used the money solely for the purpose of producing assessable income.

Where the fees to discharge a mortgage are penalty interest fees, Taxation Ruling TR 93/7 states that 'where the repayment of loan moneys borrowed for the purpose of producing assessable income is secured by mortgage, penalty interest payable on an early repayment which effects a discharge of the mortgage will generally be deductible under section 67A of the Income Tax Assessment Act 1936 (rewritten as section 25-30 of the ITAA 1997)'.

http://www.ato.gov.au/rba/content.asp?doc=/RBA/Content/14071.htm

 

[oracle]

In that case, if you are allowed to claim the break fees in the same year, it might in some situations economically better to break, then to pay extra the interest.

Cheers,
Oracle.

 

[Rob Williams]

In that case, if you are allowed to claim the break fees in the same year, it might in some situations economically better to break, then to pay extra the interest.

Cheers,
Oracle.

Totally!! It changes things quite a bit

 

[oracle]

Totally!! It changes things quite a bit

I have emailed my accountant to inquire and get a second opinion.

Cheers,
Oracle.

 

[marg4000]

We broke a fixed loan back in the 1990s when interest rates went down suddenly and were advised we could claim the break fees as a tax deduction. Only about $1,500 back then in circumstances similar to now (one year into 5 year fixed loan at 11%, interest rates dropped by nearly 2%).

Things may have changed - check with your accountant.

Back then we broke even after 5 months so a bit of a no-brainer.
Marg

 

[Rob Williams]

I have emailed my accountant to inquire and get a second opinion.

I emailed mine for a second opinion, too.
She said "OK, you're ugly, too".
Seriously, she said that depending on the breakdown of the break fees, it could be claimable in the year it's incurred.

 

[silversands]

I only regret that we did not know of that ruling back in September/October when we first considered breaking.
We had one fixed @ 7.8% and Bank S.A. wanted around $6k to break a $155K loan with 25 months left to run. We thought this was absurdly high considering we'd have been exiting to (what was then) a much higher variable interest rate. Had we realized the extent of the tax benefit, (and in all honesty had any clue just HOW far rates would fall, we definitely would have taken the hit on the chin. I shudder to think what they'd want to break it now. I actually doubt the idea would be worth entertaining, but if someone knows for sure that variable will go to 3.5% soon and stay there - let me know!

With the benefit of hind site we would have been way on top if we paid the break fees.

Chromium, hope you make a better, more informed choice. Get busy with that calculator.
As Rob indicated, remember to factor in the *opportunity lost cost* as well if you plan to accumulate more soon.

 

[Pushka]

We had to pay $2200 in break fees on a variable loan when we refinanced. At least we can claim it this year then! Thanks Rob for another PDF to store in case it is needed! Can't give you kudos coz I need to share the luv!

 

[Rob Williams]

With the benefit of hind site we would have been way on top if we paid the break fees.

That's the problem with the whole break cost scenario. By the time you realise it might be a good idea, it's already too late.
Like Bill Zheng said to me - you're going to cry now if you break. You're going to cry more later if you break. The question you have to ask youreslf is how hard do you want to cry. There is no "no cry" option available.

 

[Ms Jade]

Hey Chromium,

We decided to pay 20k in costs to get out a fixed loan in Jan, thinking that rates would drop 1% in Feb and would probably drop further. We paid it out of offset equity account (so similar to you using LOC). Here's how i see your scenario:

Rate differential 9.00 to 5.04 = 3.96%
260k (loan size) x 3.96% = $10,296 pa or $858 per mth.
You have 28 mthly payments left (i assume) on fixed rate term, so
28 x $858 = $24,024 in extra interest. Will this hit on your cashflow harm you over the next couple of years?

Theoretically, IF the variable rate stays at 5.04 for this whole time you would be better off financially sticking to fixed (24k as opposed to 28k to break).
If the variable drops (and let's assume it will) this will change the equation but who knows what the change in rates will be between now and June 2011? You could take a punt that rates will drop at least another 0.75 this cycle, leaving a variable of 4.29%. That would shave $1020.50 off your monthly interest bill and (if rates stayed there) you would pay back the 28k break costs in 27.4 mths = back to where you started.

I would probably break if I were you, for the following reasons:

1) As mentioned you can claim the deduction (may or may not be a big deal for you but very helpful to my situation)

2) You have the benefit of increased cash in a time where cash is king. It gives you better serviceability & flexibility, and

3) It's likely that you can fix again between now & 2011 at a much lower rate that 9%, thus providing some insurance into the future (i.e. You can probably fix for 5 years at sub 6% over the next 6 mths and have some surety of low rates until 2014).

Good luck!

 

[Gools]

(24k as opposed to 28k to break).....

2) You have the benefit of increased cash in a time where cash is king. It gives you better serviceability & flexibility.....

I prefer to look at the first bit as 28k now or 24k spread over the next 28 months.

Not sure the second bit is approriate at all. If cash is king then surely it is better to not pay the 28k now, the LOC will still be available later to make the repayments if necessary.

Thoughts?

 

[Rob Williams]

I prefer to look at the first bit as 28k now or 24k spread over the next 28 months.

Depending on circumstances, it could be better to pay the "soft dollars" over time rather than "hard dollars" now. The former spreads the cash flow AND the amount repaid gets devalued over the term of the repayment at the rate of inflation.

 

[Chromium]

Hi Ms Jade.

That is quite helpful and very comprehensive.

After lot of discussion with my better half...we have decided..
not to breakout from our existing fixed term.

( Atleast thats what we have decided for time being..)

We will just cop it sweet for a while. Thankfully our PPOR fixed is maturing in
May 2009. May be a possibility to spare some money from there.