Line of Credit questions

In my experience to use a LOC properly you need to be very disciplined.

The drawings, for the interest to be tax deductable must be used only for investment purposes. You can’t draw on your LOC to pay for the groceries.

Repayments are usually the interest only. So again, the temptation is to only make that payment and not reduce the principle.

The advantage is the flexibility. If you need money fast, it is there for you without having to reapply for it each time.

Used sensibly I think they have many advantages.

Shushar

“All our dreams can come true, if we have the courage to pursue them.” – Walt Disney

I went for the maximum amount. Obviously, that was linked to my ability to service and the new valuation. However, I thought the higher LOC available, the greater options I would have, as I had not at the time, identified next purchase. My LOC is not a huge amount in anycase (50k).

James

Ben

That is a good strategy that you have described. ie set up a LOC (or redraw, it doesn’t matter) and then take deposits from this account for the new IPs.

When you go for future loans, the lenders will want to assess yuor serviceability on the full limit of the LOC, not just the outstanding balance, so it will affect your serviceability in that sense.

Terryw
Discover Home Loans
North Sydney
[email protected]

Ben,

It is dangerous to use a line of credit facility on a rental property loan when you will be drawing funds back out to pay private expenses. Based on the principle that the interest on a loan is tax deductible if the money was borrowed for income producing purposes, the interest on a line of credit could easily become non-deductible within 5 years. For example: A $100,000 loan used solely to purchase a rental property in financed as a line of credit. To pay the loan off sooner the borrower deposits his or her monthly pay of $2,000 into the loan account and lives off his or her credit card which has up to 55 days interest-free on purchases. The Commissioner now considers there to be $98,000 owing on the rental property. In say 45 days when the borrower withdraws $1,000 to pay off his or her credit card the loan will be for $99,000. However, as the extra $1,000 was borrowed to pay a private expense, viz the credit card, now 1/99 or 1% of the interest is not tax deductible.
The next time the borrower puts his or her 2,000 pay packet into the account the Commissioner deems it to be paying only 1/99 off the non-deductible portion i.e. at this point there is $96,020 owing on the house and $980 owing for non-deductible purposes. When, 45 days later, the borrower takes another $1,000 out to pay the credit card, there will $96,000 owing on the house and $1,980 owing for non-deductible purposes so now only 98% of the loan is deductible, etc, etc.
In addition to the loss of deductibility, the accounting fees for calculating the percentage deductible could be high if there are frequent transaction to the account. The ATO has released TR2000/2 which confirms this and as it is just a confirmation of the law is retrospective.
To ensure deductibility and maximise the benefits provided by a line credit you will need an offset account that provides you with $ for $ credit. These are two separate accounts – one a loan and the other a cheque or savings account. Whenever the bank charges you interest on the amount outstanding on your loan they look at the whole amount you owe the bank i.e. your loan less any funds in the savings or cheque account.

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