NZ Herald 24 March 2007

AFirstly, borrowers don’t usually extend the term of their loan when the fixed-rate period ends. Usually, a mortgage originally set at 25 years runs for just 25 years.

However, if the interest rate rises, sometimes the term is extended to reduce the payments.

And you’re quite right, people sometimes get interest-only loans and 50-year-olds get 25-year loans. Should banks do that?

Let’s not blame the person who sells the candy, but rather the one who buys too much and gets fat on it.

Market forces and Reserve Bank regulations limit what banks lend. If they make too many bad loans, they will find themselves in trouble.

Sure, they can foreclose on mortgages. But that is costly, and not exactly great for customer relations. Banks generally try to avoid foreclosures by lending wisely.

Whether it’s wise for customers to take all that banks offer them is another question.

People who keep extending the term of their mortgage, or take an interest-only loan, will end up paying huge amounts of interest. But that’s their choice.

Hopefully, they do this for just a short period — tiding them over a redundancy or other cash flow crisis — and then get back to getting rid of the mortgage.

As for the 50-year-olds, they might work until 75, or get a big pay rise or inheritance or redundancy in the meantime, and repay the loan early.

If they come to a point when they simply can’t pay the mortgage, they can always sell down. Usually, though, if someone really wants to stay in a house they find a way to do it.

In summary, we never know about others’ circumstances. And I much prefer to see banks free to be flexible rather than heavily regulated.

You will probably be pleased to know, though, that the Reserve Bank is considering making life a bit tougher for banks by making them hold more reserves. This should reduce mortgage lending, “while at the same time ensuring that banks have an adequate buffer against a possible housing downturn,” the Reserve Bank said last week.

AOn your first question, that’s one way of looking at it. Predictably, perhaps, Peter Frawley of Inland Revenue has a different perspective.

“The new fair dividend rate method seeks to tax an amount approximating a reasonable dividend yield on a person’s investment each year,” he says. “This is set at a maximum of 5 per cent of the investment’s opening market value.”

Some argue that 5 per cent is not a reasonable amount, as dividends on non-Australasian shares are usually lower than that. In effect, then, part of the tax will sort of be on capital gains.

Nevertheless, strictly speaking the new tax is not a capital gains tax. And that means, says Frawley, “it is not appropriate to recognise capital losses.

“It is an inherent feature of the new method that no losses are carried forward as each year is treated separately. Any method which involves carrying forward amounts (whether gains in excess of 5 per cent or tax losses) would be much more complex than the new method.”

Frawley also points out that under the current law “people are still taxed on their dividends even if their shares go down in value, resulting in a net loss for the year. Under the new fair dividend rate method no tax would be payable in such an income year.”

There will be market crash years when we are glad we are in the new regime rather than the current one. It’s a swings and roundabouts thing.

On currency changes, the situation is the same, really. It won’t matter whether the value of your offshore shares changes because of changes in the share price in the home country or because of currency fluctuations.

But changes in New Zealand’s exchange rate with one country will to some extent be offset by changes with another country. And over the years, there’ll be ups and downs. Regardless of tax, any investor in offshore shares needs to learn to ride those waves.

The answer to your third question is “Yes, you can ignore the tax.”

The new rules don’t apply to individuals whose non-Australasian offshore shares cost less than $50,000. It’s irrelevant what happens to their value after purchase.

AProbably the latter.

“Any transaction that is done for the purpose of reducing tax could trigger the general anti-avoidance provisions in the Income Tax Act,” says Peter Frawley.

He adds that “individual facts and circumstances are taken into account.” But it might be pretty hard to argue that you had any other purpose.

And, knowing that people are thinking of using this strategy, I wouldn’t be surprised if Inland Revenue takes particular interest in share trading over the next few months.

Only you can decide if the strategy is worth the hassle, costs and possibly sleepless nights.

If you do sell and then repurchase your shares, under the new fair dividend rate rules shares bought during a tax year, and dividends on those shares, aren’t taxed, says Frawley. They come into the regime the following year.

By the way, if you sell and then buy back less than $50,000 worth, you would be under the $50,000 threshold. So you would be taxed under the current regime, which means your dividends would all be taxed.

AYour competitor Sentinel has had free publicity in this column lately, so I guess it’s your turn.

And it’s interesting that you offer lifetime interest rates. Whether they are a good deal depends, of course, on how high they are. But let’s not go there. Interested readers can contact you.

AAnd another one! Clearly the bells and whistles on HER products vary widely. The message: shop around.