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Ask the expert
The rate dilemma
Adam Miles, Lift Capital
I’m not sure whether I should take out a fixed or variable rate margin loan. What are the advantages and disadvantages of each, and what type of investor do they suit?
Your choice of interest rate on a margin loan (variable or fixed) depends on your financial and tax circumstances, your opinion as to the direction of interest rates over the term of the loan, and the flexibility required to vary the loan size over its term.
These are best explained as we explore the interest rate choices.
1. Variable rate loans
The rate on these loans can change (up or down) at short notice reflecting movements in interest rates as set by the Reserve Bank of Australia on a monthly basis or sometimes fluctuations in rates in the financial markets. There is no specific loan expiry date. Accordingly, the loan remains in place on an evergreen basis as long as there are no breaches in the prescribed gearing level. Interest is calculated daily and added to your loan balance at the end of each month (subject to your gearing level). Alternately, you can elect to pay the interest directly yourself. Importantly, interest is only calculated for so long as there is a loan outstanding. Hence, you have the flexibility of varying the loan balance at your discretion at short notice and therefore managing your interest expense to accommodate your financial and tax circumstances.
2. Fixed rate loans
These loans have a specific term, usually 12 months. The rate is locked-in so that it remains constant for the loan term despite what happens to interest rates in the economy/financial markets. The popularity of these loans is usually high towards the end of each financial year as the entire interest for the loan term is required to be paid upfront. In this regard, you would be able to claim this interest as a tax deduction against income in the current financial year. Although there is certainty of the interest amount and upfront tax benefits arising from prepaying interest, fixed rate loans offer little flexibility in terms of varying the loan size or even paying it back early because the term of the loan is usually locked-in along with the interest rate. Interest is generally non refundable no matter when the loan is partially or fully paid. Hence, if you are considering a fixed rate loan you should expect to be committed financially for the loan term.
Investor suitability to variable or fixed rate loans is therefore dependent on the impact of the various features of these loans on the individual investor's financial and tax circumstances, investment horizon and borrowing flexibility. Accordingly, you should consider obtaining independent professional advice before choosing an interest rate on a margin loan.
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