After tax costs and returns

WITH MARY HOLM


Q: Thanks for the advice in last week's column. I'm in the 39 per cent tax bracket, so I've used my internet banking to take out an extra $200,000 on my flexible mortgage (7.5 per cent x .61 = 4.575 per cent), and I've invested it in a five-year term deposit earning 6.75 per cent.

Brilliant. But I'm a bit worried about the penalties for breaking the term deposit since the contract is so high. My wife and I have always disagreed about the merits of your advice. I think she may be coming round to my side now.

A: You are having me on, aren't you? I hope so. To get others up with the play, I said last week that if you borrow to invest, you can deduct the interest you pay on your tax return.

If you're in the 39 per cent tax bracket, your after-tax interest rate is 0.61 times the before-tax rate. So you've come up with an after-tax mortgage interest rate of 4.575 per cent.

The only trouble is, you also need to look at your investment return after tax. In this case, if the term deposit pays 6.75 per cent, you will end up with 0.61 times that, after Inland Revenue has taken its bit. That comes to about 4.12 per cent.

Paying 4.575 per cent to be in an investment that brings you 4.12 per cent is not clever. You can't say I didn't tell you this.

In last week's column, and also in the sub-heading, I said "It's silly to have a mortgage and also have long-term savings in term deposits."

And in the section about calculating after-tax mortgage costs, depending on your tax bracket, I said you should make the calculation "when you're weighing up mortgage interest rates versus after-tax returns on investments ... " If you really have done what you say you've done, I suggest you talk to your bank promptly.

If you're a good customer, they may let you undo the damage free or at little cost - given that you've only just made the move.

If not, I don't like my chances with your wife. But, please, ma'am, it's not my fault. Honest.

* Mary Holm is a freelance journalist and author of Investing Made Simple. Send questions to Money Matters, Business Herald, PO Box 32, Auckland; or email: maryh@pl.net.

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