Ignoring the Home Loan

All home loans are expensive. This is because the debt on a home loan is not tax deductible. This means that a client who earns more than $80,000 and is paying 5% on their home loan has an effective pre-tax interest rate of almost 8%.

What this also means, of course, is that every dollar paid off a home loan will earn an effective pre-tax return of 8% – capital guaranteed. This is easily the best return available for such a low-risk ‘investment,’ which is why paying down the home loan needs to be front and centre in any decent financial strategy.

Unfortunately, many financial advisers see the home loan as ‘beyond the scope’ of their agreement with their client. These advisers are worried that addressing the home loan may create risk for them, the adviser.

We see it as the other way around. An adviser who fails to address the expensive home loan as part of the client’s strategy actually increases the risk that their advice may be seen as negligent. Have you ever wondered why good GPs always take their patients’ blood pressure, regardless of the reason the patient gives for attending? It is because a good GP sees himself or herself as the patient’s key medical adviser, and routinely checks on aspects of the patient’s wellbeing that they know are good indicators of the patient’s overall health – like their blood pressure.

Well, addressing the home loan is the financial equivalent of taking your client’s blood pressure. In one unfortunate SOA that we came across, the client’s asset profile even revealed that they had $40,000 in a low-interest bearing cash account and an amount greater than that owing on their home loan. When questioned about it, the client simply said that they were saving the money “for a rainy day.” To continue their analogy: how about using the cash now to fix the hole in your roof? That way you are safe and sound when the rainy day comes.

That $40,000 was earning no more than 2% in the cash account. And this 2% was taxable in the client’s hands. A simple suggestion to deposit the cash into the home loan account would save (i.e. earn) that client an effective pre-tax 8%. This leaves the client ahead by 6% pre-tax. That is the equivalent of $2,400 per year. This step alone would more than pay for the financial adviser’s annual fee for this client.

So, we strongly encourage all financial advisers to consider effective debt management as within the scope of pretty-much any piece of financial advice. If your client does not ask about it, please raise it yourself. Even if they then choose not to act on what you suggest, the fact that you suggested it makes your SOA a much more robust document.

The Dover Group