Central to most financial plans is the appropriate structuring of credit where tailoring a client’s loan portfolio can assist with cash-flow management, in reducing debt and in saving on interest and/or tax – it can also be a financial tool to build wealth and facilitate a client’s lifestyle.
This article looks at several strategies that when used in combination with your client’s advice will allow their debt to work more effectively and help them achieve their financial independence earlier than planned.
If the value of a client’s property has increased then refinancing can unlock this equity to access funds for a deposit on an investment property, for personal investments in a business or in stocks and shares as a part of their wealth creation strategy, to renovate their home, to upgrade the family car or for other purposes such as to assist with children’s education.
The various debt purposes can be isolated in separate splits within the one home loan package. This allows better management of tax-deductible debt, and as with consolidating debts, allows shorter loan terms for debt relating to shorter-term assets.
Gearing to build wealth
With the right strategy, borrowing money to make an investment can enable your clients to build their wealth faster than if using their own capital. To be successful, the investments acquired with the borrowed funds must generate a total return (income and capital growth) greater than the after-tax costs of financing the investment – including the interest. This is commonly used for property and shares through borrowing against the equity in their home or margin lending.
Debt recycling to build wealth
With the right investment strategy debt recycling can be used to help your clients build their longer-term wealth, whereby the equity in their home is used to establish an investment loan, and these funds are used as a part of their investment strategy. The investment income earnt is then used to reduce the outstanding non-deductible home loan balance and create more equity to purchase additional investments.
Reduce inefficient debt
If your client is spending less than they earn, a consideration may be to use this surplus cash flow to accelerate the repayment of their home loan. The benefits of this are to reduce the loan term, save on interest and potentially create equity that could be used for other purposes. Simple structural changes such as increasing repayment frequency, increasing repayment amounts, or directly depositing their salary to an offset account can reduce your client’s inefficient debt more quickly.
A home loan rate is potentially the lowest form of interest your clients will pay. Credit card and personal loans can have rates up to four times higher. If a client has personal debts you may want to consider consolidating them into their mortgage. Essentially, they increase the mortgage on their home (assuming there is equity) and use the extra funds to pay off the personal or credit card debts. The overall effect being the lower mortgage rate will apply to all their debts.
Clients should aim to continue to make the same level of overall repayment, which will decrease the length of the loan and with a car loan for example, that component should not last beyond the useful life of the car. Clients should close the credit card or other facilities they have refinanced.
Use cash reserves effectively
If a client has a large amount of cash in savings, they may be used more effectively by transferring them into an offset account linked to their mortgage. This will reduce the balance your client’s interest is calculated on and effectively earn them a higher after-tax return than if in a cash account. Additionally, if they keep repayments at the same level, they can still reduce the term of their loan through reductions in monthly interest charges. If the loan is for investment, an offset account will allow the client to save interest, while still preserving the deductible debt level.
Investing in real property through an SMSF
Through a limited recourse borrowing arrangement (LRBA) clients can purchase real property through their SMSF. This can be a residential investment property, or for the self-employed and small-business owners, a commercial investment property where the SMSF is the owner of the premises and the business is the tenant paying a market rent to the SMSF.
Using an inheritance
If a client receives a financial windfall they can use this to reduce their home loan debt and borrow an equivalent amount for investment purposes – effectively replacing inefficient debt with efficient debt and establishing part of their investment portfolio and wealth creation strategy.
Client circumstances change, interest rates change and mortgage products become superseded and outdated. Through regular review of any existing loan facilities, your clients can potentially secure a better interest rate, reduce their repayments and build equity. The review will also allow them to take advantage of more flexible terms and features that may be more appropriate for their current situation or that were not available when they originally took out their loan.
Move from a low-doc to full-doc loan
If your client is currently on a low-doc loan it is likely they will be paying a higher interest rate. If their employment and finances have become more stable it may be an opportunity for them to switch to a full-doc loan, where there may be a lower interest rate, lower ongoing fees or more flexibility.
Supporting lifestyle in retirement
A reverse mortgage allows clients over a certain age, to borrow against the equity in their property. This group often find borrowing on standard terms difficult to achieve. Repayments are not required, as the interest capitalises over the life of the loan. However, deposits can be made at any time. They can be very effective, for example, providing some short-term cash to avoid the need to sell a well-performing investment. With the right guidance, a well-managed reverse mortgage can provide the opportunity to enhance a client’s lifestyle in retirement.
While these strategies need to be considered in the context of a client’s overall advice and strategy, with the right processes to identify the opportunities and the right mortgage broker alliance to implement the opportunities, practices can add significant value to their clients in helping them achieve their financial goals and objectives.
Anthony Landahl, managing director, Equilibria Finance
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