By: Adrian Mastracci
North Shore News
Business Section, “Loose Change”
Sunday, August 18, 2002

Incurring non-deductible loan interest can slow down financial progress.

As we periodically focus our attention on our finances, the deductibility of loan interest paid is an important planning opportunity to revisit.

The prime loan rate charged by lending institutions has been cut from 7.5% in January 2001 to a recent 4.5%. That alone is a significant saving.

However, borrowers are far better off to incur deductible loan interest. And to pay off non-deductible loans as quickly as possible.

The impact of loan interest deductibility is illustrated with the following table. It demonstrates the effective costs of a 6% loan rate, for both deductible and non-deductible interest, calculated for three BC income tax rates:

Let's understand the implications of interest deductibility in the 43.7% tax rate.

If the 6% loan rate is non-deductible, you'll first have to earn 10.7% and pay the income taxes to have the 6% to pay the loan interest. If it's deductible, the real cost is 3.4% after the saving on income taxes.

The 7.3% cost difference between deductible and non-deductible is a significant spread to pass up in the 43.7% tax rate. Incurring non-deductible interest is costly, even in the lower tax rates.

These suggestions assist your interest deductibility strategy:

• Don’t get in over your head with debt of any type. You may be flirting with financial ruin.
• If you have only one loan, and the interest is non-deductible, establish a repayment plan so that interest costs can be minimized by repaying the loan as soon as possible.
• If you have more than one type of loan, segregate each loan so that there is no confusion if any of the interest is considered deductible.
• If you have both non-deductible and deductible loans, make “interest-only” payments on the deductible loans. Then direct all saving capacity to repaying the non-deductible loans, starting with the highest rate one.
• Business owners are advised to also segregate the business loans from the personal loans. Repay the personal non-deductible ones first and leave all others at interest-only.
• Be extra careful if you have an investment loan where the asset you purchased has been sold. The interest cost on any remaining outstanding balance is no longer deductible.
• If your interest payments are non-deductible, review your situation with your trusted investment advisor to determine if you can achieve some deductibility.
• Remember that any borrowing incurred for RRSPs is no longer deductible.
• If your finances permit, reduce the home mortgage amortization from the typical 25 years to the 10 to 15 year ballpark.

Clearly, it’s wise to review the interest deductibility for each loan. You can dramatically improve your finances by accelerating the repayment of non-deductible loans.

Minimizing the impact of non-deductible interest builds your nest egg sooner. That's a real bonus.

NOTE: The information provided above is intended for general informational purposes only. It does not constitute advice for anyone's specific situation. Everyone should always first consult directly with their advisors to determine the appropriateness of any information contained above before taking any action. KCM Wealth Management Inc. assumes no responsibility for any loss or damage arising from the use of, or reliance upon the above information.