Join our investing community

Capitalise or Prepay interest on Margin loan?

Discussion in 'Managed Funds & Index Funds' started by artgul, 9th Apr, 2007.

  1. artgul

    artgul Well-Known Member

    Joined:
    16th Aug, 2005
    Posts:
    77
    Location:
    Sydney
    I have a question I'd like to check if someone can assist me with- What would be a better strategy and why?:

    1- To capitalise interest on a margin loan or
    2- Prepay in advance the interest for a year using funds from the same margin loan

    For the 1rst scenario LVR would start at 50%. For the 2nd scenario I'd say LVR will start at around 53%.

    Thanks,
    artgul
     
  2. Glebe

    Glebe Well-Known Member

    Joined:
    15th Aug, 2005
    Posts:
    932
    Location:
    Sydney, NSW
    Capitalising is popular around these parts :) and for good reason in a bull run.

    I'm more conservative than others in this respect though, and pre-pay for 12 months each June (end of FY).

    This allows me to get a small deduction in interest cost, and claim it against income immediately effectively.

    Then when growth occurs to my portfolio during the year I tap into this equity by buying more shares or units.

    The only thing is that each year the money I need to save to pre-pay the interest has increased quite a lot, so it's becoming a savings challenge. I could always get my distributions in cash but I'd rather not at this stage if I can help it.
     
  3. artgul

    artgul Well-Known Member

    Joined:
    16th Aug, 2005
    Posts:
    77
    Location:
    Sydney
    Hi Glebe, I'm trying to understand the differences (pros and cons), between capitalising the interest or prepaying it in advance but, using funds from the marging loan.
    Thanks,
    artgul
     
  4. Simon Hampel

    Simon Hampel Co-founder Staff Member

    Joined:
    9th Jun, 2005
    Posts:
    4,619
    Location:
    Sydney, Australia
    You are capitalising the interest in both scenarios, so the only real difference is in the timing of the payment.

    Paying in advance

    Pros:

    • slight discount on interest rate
    • bring next year's expenses forward to this year, offsetting this year's income
    • remove interest rate fluctuations

    Cons:

    • need sufficient LVR capacity to capitalise a years worth of interest
    • interest rate discount is relatively trivial
    • bringing forward expenses creates a potential tax problem the following year, unless interest is pre-paid again (needs to be done perpetually - at best deferring the expense)

    Capitalising without pre-paying

    Pros:

    • LVR capacity requirements significantly less - can potentially afford to gear higher

    Cons:

    • subject to interest rate fluctuations (unless you fix interest rates, but pay in arrears)


    ... so which is better ? That's up to you !!!
     
  5. bundy1964

    bundy1964 Well-Known Member

    Joined:
    22nd Dec, 2006
    Posts:
    351
    Location:
    Adelaide, SA
    I have gone capitalised and with the bumpy ride that was March this is the first month that I have had to pay interest as I was mostly holding and not trading. I also found out I now get a discount of 0.25% from the standard rate which most likely is from holding their shares. It also lets me grow without the interest playing such a big part being upfront.

    All I could find was this in the FAQ.
     
    Last edited by a moderator: 11th Apr, 2007
  6. gad

    gad Well-Known Member

    Joined:
    5th Sep, 2005
    Posts:
    150
    Location:
    Canberra
    You can capitalise the interest & still claim that interest against your income in your tax return, which can be quiet beneficial.
    Although I would only do that if I was reinvesting, or at least, reinvesting 50% of the distributions to keep the LVR in check.
    And that is while we are enjoying such favourable market condition, strategy may need to change if (& when) the market conditions change (& they will).

    Edit:
    I should have also mentioned that by capatalising you interest, your debt will get higher but as long as your keeping your LVR to a managable rate (say 50% to be conservative), the growth in your funds will well compensate for that increase in debt.
    (Read some of Sims earlier threads on managed funds).