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% dif required to make int in advance worthwhile??

Discussion in 'Finance & Banking' started by handyandy, 31st May, 2007.

  1. handyandy

    handyandy Well-Known Member

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    Hi All

    I am sure I have seen it discussed previously but can't seem to locate it.

    I am considering paying fixed interest in advance (yearly) with the offer at 7.25% compared to 7.6% variable. Obviously you are paying the whole amount in advance so there is an oppurtunity cost associated with the advanced payment which must equate to some % point.

    What is the calculation that would give me the real % saving I make if I pay in advance?

    Thanks in advance
     
  2. Nigel Ward

    Nigel Ward Team InvestEd

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    It's not just the discount is how much tax you'll get back and what you can earn with that money as opposed to the money you've prepaid.

    N.
     
  3. handyandy

    handyandy Well-Known Member

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    Thanks Nigel.

    The interest will be capitalised. The reality is that I would not be using these funds to invest elsewhere. If I was to increase my holdings then I would just draw from other sources.

    Also ignore any tax advantages as I am paying tax regardless of what I do and expect to make the same income or better the next year.

    So my question still stands as to what is the real % difference between paying 7.25% annually in advance as against 7.6% monthly in arrears.

    Cheers
     
  4. Nigel Ward

    Nigel Ward Team InvestEd

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    It's the difference between 7.25% x loan value today

    VS

    the Net Present Value of the 12 monthly payments at 7.6%/12 x loan value
     
  5. MattR

    MattR Well-Known Member

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    What about the fact that the 2007 tax return may not need to be lodged for 10 1/2 months and then the debt paid another month later

    Say you prepay $20,000 on 30/6/07 and claim as a deduction in your 2007 tax return. This could save $9,300 that could be reinvested. But your out of pocket $20000 from 30/6/2007.

    But you may want to consider that that $9,300 could be payable in say 6/6/2008 if you hadn't claimed that $20,000 deduction. That would give you an extra $20,000 to reinvest for almost a year.

    I know that you could also in theory lodge on 1/7/2007 and get your $9,300 refund a fortnight later, so you'd have a net deficit of cash of only $10,700.

    I haven't done any numbers but I guess it really depends on the rate of return you can get.
     
  6. DaveA

    DaveA Well-Known Member

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    i did this spread sheet a few months ago, i cant remember if i posted it...

    it deals with the interest that would need to be paid upon the interest capitlised, 1st sheet gives you the simple version of this is your real interest rate, after you paid from interest on interest, if this is equal to or higher than the variarable then its not worth it.

    the last one is if you pay your tax deduction into the interest balance when your refund is recieved...

    it doesnt take into account time value of money, or opportunity cost

    if you need me to explain it further just let me know...
     

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  7. handyandy

    handyandy Well-Known Member

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    Hi Dave

    That pretty well what I was looking for. :) As it turned out I must have even taken a copy as I found a copy on my PC:eek:

    Anyway, using the spread sheet I get an effective rate of 8.2% if the interest is paid monthly and capitalised. This is starting with a quoted interest rate of 7.6%

    If I use a simple approach with the yearly prepaid and capitalised, then I take the total $ interest to be paid, calculate the extra interest and accrue this on capitalised amount, add these extra dollars back to the total. Then work back to a % figure. Based on this sort of calc I get an effective rate 7.77%.

    $1mil interest at 7.25 = 72500
    $72500 at 7.25 = 5256
    Giving a total interest of 77756
    77756/1mil = 7.77% :confused:

    How does that look????

    Cheers