Consumer debt
Consumer debt is debt incurred on consumer products and services. You don’t get a tax deduction for this sort of debt, so it is really far more costly than tax deductible debt.
Consumer debt is usually very expensive – some credit card debts charge up to 22% per annum – and is not tax deductible because it does not relate to taxable income i.e. it was not a necessary outlay in producing investment/business income.
We have seen clients with a credit card debt of more than $200,000 at 22% interest. The minimum payment was about $50,000 a year. On top of living expenses, they had to earn an extra $93,000 a year just to make the minimum credit card payments. They had to earn $93,000, then pay the $43,000 tax due on that income, leaving $50,000 to pay off the credit card. That’s extremely expensive money and it’s impossible to get ahead with that sort of a millstone around your neck. This is all before finding money to live on.
Luckily many people know consumer debt is expensive and avoid it wherever possible. However most people still pay such high interest on consumer debt. This behaviour in reality takes the cream off their livelihood and wealth creation. Our client ended up consolidating the credit card debt on to his home loan, and effectively reduced the interest rate to a much more manageable 4.5% per annum. This was not hard to arrange as the client had spare equity. However people who live high on consumer debt often have no equity to rely on. This client was one of the lucky ones.
Home loan debt
Home loan debt is debt incurred on buying, maintaining or improving a home.
Home loan debt is usually not that expensive, since the loan will be secured by mortgage over the home, and this means there is little risk for the lender. Interest rates are currently about 4.5%.
Home loan debt is not tax deductible. It is not incurred for the purpose of producing taxable income and it is inherently private and domestic in nature. Depending on your tax rate, this means people have to earn around $1.87 for every $1.00 of home loan payment. In other words, a non-tax-deductible home loan means that to pay say $2000/month on a home payment means you need to earn $3,738, pay $1,738 in tax to have $2000 left over for that monthly home payment. That’s still expensive money, and although not impossible, it’s hard to get ahead with that sort of a millstone around your neck.
Step one in real wealth creation is to eliminate non tax deductible debt in the shortest possible time.
Everyone should pay off non-tax-deductible home loans as fast as possible. That’s where Canterbury comes into it. It is common for our clients to pay off a 20 year home loan in 5 years or less. That’s a saving of 15 years in home payments. To be gifted an extra 15 years of freedom like that opens the door to being able to plan your future live in a way not otherwise possible.
Are there faster ways to pay off a home loan? Yes there are – and we know them all.
Just compare:
The Old Way: Say you had a 20 year home loan at 4.5% with payments at $2000/month. The total interest paid would be $163,678 over 20 years.
The New Way: If you allowed the Canterbury system to be implemented for you, the total interest over the new 5 year time period would only be $38,792. Not only do you win a 15 year reprieve on home payments, but you pocket the $124,886 in saved interest.
Investment debt
Investment debt is different to consumer debt. Properly managed investment debt improves your economic returns and helps build long term wealth.
The ASX Report for 2013 says Australian property earned an average of 9.5% per annum (residential real estate was even higher) and Australian shares earned an average of 9.8% per annum over the two decades to December 2012. The difference is you can own a lot more real estate than shares using the same deposit. Shares are harder to borrow against.
This means that people who borrowed to buy representative properties and shares over the last two decades dramatically increased their wealth by doing so. A property return of 9.5% might not sound significant, but it does turn $400,000 in real estate into $2.2 million in 20 years. You have to be “in it to win it.”
Property investment debt is a painless debt to hold because it’s tax deductible. You don’t have to earn $3738/month to pay a $2000/month payment as described above.
If your investment property payment is $2000/month, you don’t have to find extra money. In fact you don’t have to find any money at all because the payment is more than covered by the rent and tax rebate each pay day. A typical situation is that with a $2000/month investment property payment, the net rent would bring in $1902/month and the tax rebate would give you $653/month – a total of $2555/month (don’t forget the required monthly payment is only $2000). No-one has ever gone broke with a $555 monthly surplus cash flow.
Of course there is still a little bit to pay towards rates and insurance, but I’m sure you understand the point.
Canterbury Property Services having been fitting these pieces together for clients and implementing our proven plan for 36 years now.