Interest In Advance

By Matthew Kenworthy | Property Investors

Interest in Advance (IIA) allows investors to pre-pay next year’s interest now as a lump sum. This allows the prepared investor to claim the interest as a tax deduction a year earlier.

Most lenders will offer an increased discount off their fixed rates when prepaying interest. As the interest is paid in advance, this option is only available on fixed rate loans.

Many lenders will offer IIA loans with terms ranging between 1 to 5 years. Whilst you can fix for longer than 1 year, the interest is only paid one year in advance. In effect, you’re converting your repayments into one annual lump sum.

Most investors would seek to apply for an Interest in Advance loan late in the financial year.

It is important to note that this information is of a general nature only and is not considered tax advice. For advice specific to your situation, we recommend you speak to an Accountant or Tax Advisor.

Who Can Prepay Their Interest

Most lenders will only allow prepaying of interest on investment loans.

Whilst all the major banks currently offer fixed interest in advance, not all lenders do. If you are considering pre-paying interest, check with your lender before taking out an investment loan. You may also consider refinancing your investment loan to a bank that does offer this feature.

To qualify for interest in advance you will need to have savings. You will need to show the lender you have enough funds to meet the annual interest repayment.

For example, consider the following scenario. An investment loan of $400,000 and a fixed interest in advance rate of 3.99%. You would have to have funds to prepay $15,960 in interest.

Why Should I Pay Interest in Advance

There are two main reasons for paying interest in advance:

  • Extra Lender Discounts
  • Tax Concessions

Extra Lender Discounts

Many lenders are currently offering an increased fixed discount of -0.20% when prepaying interest.

On an investment loan of $400,000, a -0.20% pa interest saving reduces your interest bill by $800 pa.

Tax Concessions

Prepaying interest is a way of bringing forward a tax deduction. That deduction would have been claimed the following year. This can be helpful for many reasons including:

  • If you’re likely to be in a higher tax bracket this year than next.
  • Receiving the tax benefit earlier rather than later.

To get an accurate calculation on the potential tax benefits value we recommend speaking to your accountant or tax advisor.

What Are The Disadvantages?

As a fixed rate loan product there are some disadvantages that should be considered.

No Extra Repayments

No extra repayments are permitted whilst the interest has been prepaid in advance. This makes sense as if you have already prepaid the interest so there would be no benefit to paying off extra.

Break Costs

As with any fixed rate if you look to pay off your home loan early you may incur an early repayment penalty. This depends on many factors and is not ascertainable in advance.

If you are uncertain about keeping the property over the term, consider other options.

Lump Sum Payments

As you must pay the interest in a lump sum you will need to have cash savings to make the first repayment. If fixing for more than 1 year you would need to ensure that you plan to have the funds available in future years.

Switching Back

There may be a time when you look to switch back to paying interest in arrears. In this case, there would be a 12 month period where you received no interest tax deduction.

In Summary

If you’re looking at an interest in advance loan and would like to see what options are available we can help. We can calculate the numbers, and show you the comparison between different lenders.

We can provide you with a comparison report which you can discuss further with your tax advisor. If you would like to proceed we can help you through the process.

It’s important to keep in mind that it does take some time to process Interest In Advance requests. If you are looking at this option we recommend applying sooner rather than later.

About the Author

Matthew Kenworthy is a specialist in all aspects of Residential & Commercial Finance. He can assist all borrowers from First Home Buyers to Property Investors with Large Portfolios.