Understanding
Debt Management
Version 4.0
Preparation Date: 2 November 2009
This document provides
some additional
information to help you
understand the financial
planning concepts
discussed in the SOA
in relation to debt
management.
Important information
This document has been published by GWM This document contains general information
Adviser Services Limited AFSL 230692, about the benefits, costs and risks associated
registered address 105-153 Miller St North with certain product classes and strategies.
Sydney NSW 2060, ABN 96 002 071 749 for It is designed for use in conjunction with a
use in conjunction with Statements of Advice Statement of Advice that takes into account
prepared by its authorised representatives the circumstances and objectives of an
and the representatives or authorised individual. Before making a commitment
representatives of National Australia Bank to purchase or sell a financial product, you
Limited, Godfrey Pembroke Limited, Apogee should ensure that you have obtained an
Financial Planning Limited and Australian individual Statement of Advice.
Financial Services Licensees with whom it has As legislation may change you should
a commercial services agreement. ensure you have the most recent version
of this document.
How to read
this document
Managing your There are all sorts of issues you need to
consider such as taxation, legislation,
finances to meet protecting your wealth and assets,
your day to day associated costs and the inherent risks
of investment. When undertaking a
requirements financial plan it is important that you
as well as your
understand how these issues will
impact on you and what you should
long-term goals can expect over time.
be a complex task. Your financial adviser will provide
you with a Statement of Advice (SOA)
which sets out the details of the
advice and how it will meet your goals
and objectives.
This document provides some
additional information to help you
understand the financial planning
concepts discussed in the SOA in
relation to debt management.
It is very important that you read this
document to help you understand
the benefits of the strategies
recommended to you, and the
associated costs and risks.
Please contact your Adviser if you do
not understand anything, or need
further information or clarification.
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Understanding
Debt Management
Debt Management
Below is a brief description of the main Variable Loan Using a Redraw Facility
types of loan facilities, features and risks. Variable rate loans have an interest rate A redraw facility allows extra funds paid
Fixed Rate Loan that may change. Therefore, minimum into the loan (above the minimum
repayments may vary with changing requirement) to remain available to you
Fixed rate loans protect you against the interest rates. Generally, variable rate upon application to your lender.
risk of an interest rate rise by fixing the loans have a lower interest rate than fixed Additional repayments made directly into
interest rate applicable to all, or a portion rate loans. Variable loans also have the loan result in less interest being
of, your loan for a set period of time. greater features than fixed loans, such as charged and a reduction in the term of
If interest rates rise you will have the the ability to make additional repayments, your loan.
security of knowing that the interest rate vary payment frequency, redraw facility,
offset facility and portability. Factors to be aware of:
on the fixed portion of your loan and your
regular repayments will not change until • Depending on your loan contract,
Factors to be aware of: there may be fees payable and some
the end of the fixed period.
• If interest rates rise, your variable restrictions on minimum amounts that
Factors to be aware of: rate loan and repayments are also can be redrawn.
• Fixed interest rate loans are generally likely to rise. • If you make additional repayments
higher than variable rate loans. • You may be paying a higher interest directly into an investment loan and
• Variable interest rates may fall rate than needed, if you are not using all then redraw these funds for a
during the term of your fixed interest the features of your variable rate loan. non-income producing purpose,
rate term. the interest expenses will not be
fully deductible.
• Fixed rate loans generally have limited
features, and restrictions are applied
on additional repayments, which may
prevent you from accelerating the
repayment of your loan.
• Early payout fees usually apply to fixed
rate loans.
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Understanding
Debt Management
Debt management Inefficient Debt
strategies (Non Tax Deductible)
Using a 100% Offset Account Debt, or borrowed money, can play an Loans taken out to purchase services or
A 100% offset account can be operated important role in helping you to achieve assets which do not generate income
as your normal transaction account, your lifestyle goals and objectives. (for example, to purchase a principal
ensuring that you retain complete However, it is important that it be residence, a car or fund a holiday) do not
flexibility and access to your funds. It is a managed and structured effectively to qualify for a tax deduction in relation to
separate account to your loan, however, minimise borrowing costs. the interest costs. In these cases the
when your interest is calculated, the debt is considered to be inefficient from
The way debt is managed may depend a wealth creation perspective and is
funds held in this account are ’offset’ on whether it is considered “efficient” or
against your loan, effectively reducing often draining on your long-term wealth
“inefficient”. accumulation capacity when not
your interest liability.
managed properly.
Using an offset account to its optimum Efficient Debt Wherever possible you should try to
involves keeping all of your income and (Tax Deductible) accelerate the repayment of your
any savings in this account for as long as
possible. This effectively minimises the inefficient debt. Outlined below are
In most cases, debt used to purchase
daily balance owing used to calculate common debt reduction strategies.
assets that produce income (for
your loan interest and as a result can example, a portfolio of shares or an Reducing Inefficient Debt
also reduce the term of your loan. investment property) qualify for a tax
deduction in relation to interest costs. By accelerating the reduction of your
If you have an investment loan, there is This form of debt is considered to inefficient debt, you can:
an advantage in making additional be “efficient”. • Reduce your total interest payments
repayments into an offset account rather and reduce the duration of your
than making the repayments directly into inefficient debts.
the investment loan. While in both cases
you will reduce the effective loan balance • Increase the equity you have in your
and save interest, you are able to home, which can be potentially used
withdraw funds from the offset account as security to borrow for investment
whilst maintaining full deductibility of purposes later on.
interest on your loan. • Potentially provide you with more cash
flow at the end of the loan term that
Factors to be aware of: can either be used to repay other debt
• You may have to pay a fee or higher or to make additional investments.
interest rates for this facility.
There are various debt management
strategies that can be used to reduce
inefficient debt. We have listed some
common strategies below.
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Understanding
Debt Management
Increasing Your Making Additional Lump Utilising a Credit Card Effectively in
Regular Repayments Sum Payments Conjunction with Your Loan
Increasing the size of regular loan Making an additional lump sum You can retain access to additional loan
repayments involves transferring surplus repayment involves a one-off cash repayments through the use of an offset
cash into your loan on a regular basis. payment into your loan. account. Therefore, an effective debt
This will result in a reduction in the management strategy is to take
interest charged and principal owing on The benefit of this strategy is that you will advantage of your mortgage offset
the loan. effectively be earning an after-tax return account and the interest free period on
equivalent to your loan interest rate. It is your credit card.
Factors to be aware of: unlikely that you could obtain an after-tax
• Loss of access to your funds, unless return as high as this from other Instead of using your cash to pay your
the payments are made into an offset investments with the same level of risk. everyday expenses (and as a result
account or redraw facility. taking those funds away from your offset
Factors to be aware of: account), using your credit card leaves
• Many fixed interest rate loans limit
additional repayments and may also • Loss of access to your funds, unless your cash in your offset account longer,
charge a fee. the payment is made into an offset reducing the effective balance of your
account or redraw facility. loan and the daily interest that
• By reducing the term of a fixed interest accumulates.
loan, you may incur early payout fees.
It is important to note that this strategy
Increasing Payment Frequency on will only be effective if you pay your credit
Your Loan card debt within the interest free period
As interest on your loan is calculated each and every month. This can be paid
daily on your outstanding loan balance, via a transfer from your offset account or
the longer the period between your from other cashflow.
payments, the higher the average daily
loan balance, and the greater the interest Factors to be aware of:
charged. More frequent loan • It is important that you pay the
repayments will result in less interest entire amount owing on your credit
being charged and may result in a card each month within the interest
reduced loan term. free period.
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Understanding
Debt Management
Consolidating Your Debt Debt Recycling
A simple strategy to lower your overall In some cases, it may be appropriate to To implement this strategy, your
interest rate and more easily manage consider replacing inefficient debt with tolerance for risk should allow you to feel
your debt is to consolidate all debts into more efficient debt that can be used to comfortable with borrowing to invest.
one loan that provides a lower interest create wealth tax effectively. This There are two ways debt recycling can
rate and features to help you repay your strategy is known as Debt Recycling be undertaken:
inefficient debt faster. but should only be undertaken after a
thorough analysis of your financial Lump Sum Debt Recycling
Loan consolidation will save you interest situation. If you have available capital such as bank
where your new repayment and loan account savings, this can be used to
term are at least equal to your total Debt recycling can be an effective repay any inefficient debt, such as a
current loan repayments and loan strategy to accumulate wealth over the home mortgage or personal loan. An
terms. Otherwise, you could be long-term. It is a process of using investment loan can then be taken for
converting your short-term debts into surplus capital or cashflow to reduce the same amount and be used to invest
longer-term debt and be paying more inefficient debt and then replacing it with in an investment portfolio.
interest in the long run. efficient debt in the form of an
investment loan. The investment loan Regular Debt Recycling
Factors to be aware of: proceeds are then invested to form part If you have regular surplus income, this
• Early termination fees may apply to of your investment portfolio. The can be used to increase the regular
your existing loan(s). inefficient debt is eventually extinguished repayments on your inefficient debt,
and an investment loan with fully tax such as your home mortgage or
• The interest rate on your new loan
deductible interest remains. personal loan. An investment loan can
may be higher than rate than your
existing loan(s). There is no tax benefit available on debt then be increased by a corresponding
used for personal purposes, but a tax amount and the proceeds used to invest
• Loan consolidation can significantly
deduction is available on the interest in an investment portfolio.
increase your total interest costs, if
you make smaller repayments over a expense on investment loans, where the
longer time. loan is used to purchase income
producing assets. Debt recycling
• Application fees and stamp duty may
therefore results in a more tax efficient
be applied to your new loan.
outcome and wealth accumulation
benefits through the accumulation of an
investment portfolio. You should note
that the investment loan would need to
repaid at some point in time.
64402M1109
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