Interest in Advance

Interest in Advance:

What is interest in advance?

Interest in advance is the pre-payment of interest for a set term (normally 1 year).  Basically, the interest for 365 days is calculated and paid to the bank in a lump sum in advance.

Why would I pay interest in advance?

There are 3 main reasons why one would pay interest in advance;

1) Convenience

If you are living and working overseas it can be very convenient to pay the interest upfront in one lump sum and then forget about making repayments for the rest of the year.  Keep collecting the rent in a separate account and then use to pay interest in advance in the following year.

2) Discounted rate

Most lenders give an interest rate discount when paying interest in advance of normally 0.1-0.2% off the rate.  Another advantage is that, as you have paid interest in advance no repayments are required.

3) Taxation benefits

If the loan is an investment loan then the taxation benefits of paying interest in advance can be substantial.  To understand the taxation benefits of paying interest in advance one needs to have a basic understanding of negative gearing.

What is Negative Gearing?

Negative gearing is where the income from the property is outweighed by the expenses for that property like interest on loans, rates, insurance etc.  If the expenses are higher than the rental income then your property is said to be negatively geared.

For the investor this can mean that in many cases you will get a tax deduction for the 2009 year for the interest you have paid to date AND all of next years interest as well.

Presuming you have a decent taxable income this can result in some excellent tax savings.

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