# Loan for a term deposit? Interest difference = risk free profit?



## mshepherd (15 January 2010)

Hi All,

Just a thought about playing around with interest rates. I.e. If your able to secure a loan (possibly a large loan?) for an interest rate less than the highest long term term deposit and use the loan to fund the term deposit then the result would be a risk free profit with no capital outlay?

This was just a fleeting thought and is highly likely to fundamentaly flawed in someway, although on very quick investigation I can't see exactly why it wont work.

So the main issue would be the loan, granted a home loan is for a home, although its not like the loan money is being squandered irresponsibly, its being invested and that would help sway the granting of any loan. Therefore im assuming/guessing that there would be investment loans (preferably as large as possible) that could be secured for an interest rate less than about 8% ? 8% is the highest long term term deposit i've seen around. If the investment loan can be obtained for under that amount then the difference is risk free profit with no initial capital required.

So please poke holes in this theory if they are obvious.

Regards,


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## clowboy (15 January 2010)

It's not risk free.  Term deposits carry risk.

While I havent looked recentley I doubt very much that you could get a large (or even a small for that matter) UNSECURED loan at less than 8%.

even if it was achievable its a hole heap of work for very little reward, tying up 100k would only net you 1k if the interest rate differences are 1%, which I think is optomistic at best


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## skc (15 January 2010)

Works in theory. And if you dead equity in your own home and can get a cheap loan then go for it. But don't expect margin much greater than 1%. And don't forget if you take out a variable rate loan to put in a a 5-year fixed rate deposit, you will have problems with rising interest rates very soon.

Also you will probably need to pay the interest at more regular interval on your loan than what you get back from the term deposit.

A better way to do this is to get a credit card on a honey moon rate, cash advance that and put in higher interest account. Smaller amount but better margin.


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## Trembling Hand (15 January 2010)

This very thing has made the world turn for the last 15 years, especially an Aussies world.

Only trouble is if your assets are in Oz you're ar$e about. BUT if you are in the US, UK and Japan welcome to the carry trade.

Mortgage your house @ 4% invest in term deposit/whatever. @ 7% in Australia. Better still go to Brazil and get 12%. Of course you will have to hedge the currency risk.

then on top of that of course you could do as the Hedge funds do and leverage the hell out of the "free money" and create a nice big bubble in some financial instrument. etc etc.


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## UBIQUITOUS (15 January 2010)

mshepherd said:


> Hi All,
> 
> Just a thought about playing around with interest rates. I.e. If your able to secure a loan (possibly a large loan?) for an interest rate less than the highest long term term deposit and use the loan to fund the term deposit then the result would be a risk free profit with no capital outlay?
> 
> ...




TAX


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## clowboy (15 January 2010)

You will only pay tax on the profits (over and above the spread) as it's an investment and as such the interest should be tax deductable.........well in my limited understanding anyway


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## eddiewouldgo (15 January 2010)

Yes the "carry trade". The only way to hedge the currency risk is to trade the spot FX or currency future - both of which negate the interest differential since it is priced into the currency trade!

Leave the currency exposed and watch it swing against you when you're ready to unwind (since every other punter is the same way positioned and looking for the doors as they close).


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## Junior (15 January 2010)

The way I understand it is that the loan interest may not be deductible as the borrowed funds would need to be utilised to invest in an 'income producing asset'.  Not sure that a term deposit is classified as an 'asset' or not.


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## clowboy (15 January 2010)

Depends if you are the bank or the customer, as a customer you have an asset, as the bank it's a liability


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## awg (15 January 2010)

skc said:


> Works in theory. And if you dead equity in your own home and can get a cheap loan then go for it. But don't expect margin much greater than 1%. And don't forget if you take out a variable rate loan to put in a a 5-year fixed rate deposit, you will have problems with rising interest rates very soon.
> 
> Also you will probably need to pay the interest at more regular interval on your loan than what you get back from the term deposit.
> 
> A better way to do this is to get a credit card on a honey moon rate, cash advance that and put in higher interest account. Smaller amount but better margin.




I cant quite rid my head of the thought of 6.8% 1 year term dep, and 0 or low % for 12 month balance transfer credit cards.

I havnt researched the idea, cause i'm sure there has to be a catch.

but theoretically, cant u use a pre-existing equity loan to start a term dep, cash advance pay that with credit card, transfer balance to low interest card.

You may need to have access to that much lazy cash of yr own..ie $50k for a few days at most, near the end of the term

There must be holes though, or everyone with enough cash/assets would be doing it? ( i accept THs mention it is piddling arb really)

any more thoughts?...shoot it down and end the nagging idea by all means


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## skc (15 January 2010)

Junior said:


> The way I understand it is that the loan interest may not be deductible as the borrowed funds would need to be utilised to invest in an 'income producing asset'.  Not sure that a term deposit is classified as an 'asset' or not.




Of course it's an asset! You pay tax on the interest earned, don't you? So you can claim the expense against it for sure.



awg said:


> I cant quite rid my head of the thought of 6.8% 1 year term dep, and 0 or low % for 12 month balance transfer credit cards.
> 
> I havnt researched the idea, cause i'm sure there has to be a catch.
> 
> ...




Ideally you just keep rolling it over but really the gains will always be small compared to your asset level.  What sort of credit limits can you get as a fraction of your income? 15%? 25%? Say you are on $100K and get a $25K limit, you are making ~$1-1.5K. Nice but not really world changing.


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## mshepherd (15 January 2010)

One issue would be in servicing the loan/CC whilst the money is locked up in the term deposit. i.e. you will need to pay the borrowing costs out of your back pocket until the term deposit matures.

Also for the CC approach, there are doubts on whether a bank would offer a0%-Low% for 12month transfer on the full amount, or even for a large amount at all. Wouldn't want to get stuck with the cash advance rate.

Granted $1.5k isn't much in the greater scheme of things, although if it turns out that all that is required is a single loan application and a term deposit application then lots of people would happily put in the hour or so work it takes to get that 'free' money.


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## Krusty the Klown (15 January 2010)

This concept is known as a carry trade.

Interest on the term deposit can be credited monthly to an external account to fund loan payments provided it is interest only.

The interest on the loan is tax deductible.

Profits are taxable.

The main thing to keep in mind here is - is there a more profitable use of the leveraged funds than 1% minus tax?


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## MITCH027 (15 January 2010)

actually thats a good question - is it really an asset?

the interest you make on the term deposit is CGT or income tax?

I thought it was income tax


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## Krusty the Klown (16 January 2010)

Yes, cash is an asset, but is not captured by the CGT provisions.

Interest is treated as ordinary income, therefore subject to income tax.


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