Strange Result - urgent!

[WebBoard]

From: Russell H


I have just had a mortgage broker 'prove' through use of your fine program that paying him a fee for arranging finance ( $2600 on a $240000 loan) will SAVE me money, because ' the government want people to get good advice' and 'if I take it out the weekly cost goes UP'

Clearly, this is an absurd result - increasing costs, by borrowing more, even with a tax offset, can not reduce the cost over time.

What is he doing? Can you explain this? I suspect it is related to the deduction being spread over 5 years, but the cost is spread over the life of the loan, but I am not sure.

I put it to him that if I doubled his fee I would do even better, ( clearly absurd) but he was unable to explain other than ' that's what the program shows.'

Would appreciate a quick response, as I believe I need to cancel the agreement with him.

Russell and Meredith

 

[WebBoard]

Reply: 1
From: Ian Somers


It is sometimes possible to prove that black is in fact white. But you should be careful that you are getting the whole picture.

Assuming the loan costs are borrowed, the loan is I/O and the loan term is greater than 5 years....

1. The extra cost to you in the first year will be the interest on the extra debt (say 8% of 2600 = $208).
2. The tax benefit will be about 1/5 of 2600 (loan costs written off over 5 years or term of the loan which ever is the lesser) x your marginal rate of tax (say 43.5%) = $225.

Thus you are actually a few dollars ahead at the end of the first year ($225-208). How can this be?

Well the big picture is that the tax benefit runs out after five years and you are left with the additional debt of $2600. In fact you have given up $2600 equity in the property for a benefit worth less than $100 over five years. You cash flow may have improved by a few dollars, but in fact your return on investment will have gone down.

 

[WebBoard]

Reply: 2
From: Rolf Latham


Hi Russell and Meredith

Warning Warning Mr Smith, alien approaching. Sorry only joking but please hold onto your wallet.\\

Be advised that on an average 240 k loan a decent broker will pick up between 1440 to 1700 upfront and comm and a trail of about $ 600 per year of bank comm.

Most independent brokers do not charge up front comms. We depend upon placing our clients into great products which then provides us oodles of referrals.

Boo to those brokers ripping off the system, you are giving us all a bad name.

Please feel free to contact me for no hassle no pressure ideas, even if you are using an existing bank or broker.

ta

Rolf

 

[WebBoard]

Reply: 3
From: Terry Avery


Hi Russell,

I agree it is a strange result. A cost is a cost and even after a tax
deduction there is still a cost to be borne by you. Yes cost of loans are
deductible over five years which means it will take five years to get back
your deduction but as stated above you still have to fund the difference
between the tax deduction and his fee. You are right in that you will be
paying interest on his fee for the life of the loan and while the interest
is deductible the tax refund is not 100% so again you are out of pocket. You
should concentrate on minimising costs, lowest AAPR, lowest fees and so on.
You will have more cash in your pocket if you keep costs under control. His
logic or rather his program is a good result for him and not you.

Don't get tricked that a reduction in tax is a benefit. If you pay out $1 in
costs you get, at most, 47 cents back and are down 53 cents. If you have $1
more in your pocket you will pay 47 cents tax and be 53 cents up. Which
would you rather have, a loss of 53 cents or a profit of 53 cents (a
difference of $1.06). So while tax deductions help, not having the cost to
start with leaves you better off.

I would decline his helpful offer and find a loan which minimises the costs.