Hi,
We're new investors and have recently bought an investment property with an IO loan without an off set account option. We are able to make extra repayments up to $25K and have a redraw facility. We don't own a PPOR yet (we love where we live and the rent is well subsidised). we have recently received a lump sum of $10,000 and are trying to decide whether to put this into the loan and redraw it when it comes time to purchase our PPOR in a few years or so. I would also like to make regular extra repayments as a way of saving for a deposit on our PPOR loan. People keep telling me that you want to pay as much interest as possible on an investment loan but but how else should we invest the money?I appreciate any advice!!
Cheers!Put the money in the offset account and leave it there. If you pay it off the loan, then redraw it for personal gain (i.e your PPOR) you lose the tax deductibility of that amount on the loan.
Example…
You loan is $100,000 and it's an investment property, so the interest is tax deductible.
Put the cash in the offset account and you only pay interest on the difference – i.e if you have $10,000.00 in the offset account, you only pay interest on the loan on $90,000.
You then use the cash in the offset account as the deposit for your house The amount you pay interest on for the investment property goes back up to $100,000 and this is still completely tax deductible.Flip the coin…
Your loan is $100,000 and it's an investment property, so the interest is tax deductible.
Put the same $10,000 we used before into the loan as extra payments, so your only paying interest on $90,000.
Now redraw the $10,000 for you PPOR.
All of a sudden, you're paying interest on $100,000 again but can only claim the interest on $90,000 of that as a deduction, because the $10,000 you redrew is for personal usage.As for paying as much interest as possible – it depends on your objective. If you're looking to negative gear, then yes paying more interest is to your advantage because it increases the amount you can reduce your taxable income by. If you're looking to positively gear, then this is not the case because you're looking at INCREASING your taxable income, not reducing it…
Of course, speak to a broker and / or accountant before you do anything, as general info may not apply to you.
Hope I haven't confused you – Good Luck!thanks Imugli,
I realise now that we should have chosen a loan with the option of an off set account but unfortunetly it doesnt come with the fixed rate loan so until it changes to a variable rate in 2 years time, what should we do with the extra funds?? I also realise that we should have gone with a variable rate from the start too! Hind sight is a wonderful thing!!Deposit the funds in a nice high interest bearing account.
Richard Taylor | Australia's leading private lender
kyla wrote:thanks Imugli,
I realise now that we should have chosen a loan with the option of an off set account but unfortunetly it doesnt come with the fixed rate loan so until it changes to a variable rate in 2 years time, what should we do with the extra funds?? I also realise that we should have gone with a variable rate from the start too! Hind sight is a wonderful thing!!Sorry kyla, your initial thread said IO (Interest Only) loan. Fixed Interest (FI) is obviously a different kettle of fish and I read it as WITH an offset option not WITHOUT – apologies…
2 years fixed probably isn't that bad a bet. Depending on your circumstances, fixed interest may work better for you. For instance, you may get a benefit out of prepaying the interest on the loan and bringing the deduction forward. Talk to your accountant about that though… There's also the certainty of knowing exactly what your payments will be – just because the RBA has said it's going to lower rates, there's no guarantee the banks will follow them. Heck if the funding markets don't open up a little, we may still see banks RAISE their rates.
As you can see by Richard's post count – he da man. From what I've gathered so far, if he doesn't know it when it comes to financing and structuring, it's probably not worth knowing.
i'd pay off the loan if interest earned in a bank desposit is going to be taxable at resident's tax rate. why pay bank mortgage interest when you don't have to? Set aside some emergency funds (in a high interest bank account like BankWest Telenet) to last you 3-6 months, but anything over and above that, you should try to pay off your loan as much as possible, even if it is IP and you get tax deductions on the mortgage interest.
live below your means and try not to redraw, and listen to Dave Ramsey on iTunes' daily podcast for some interesting thoughts on debt.
JRr wrote:i'd pay off the loan if interest earned in a bank desposit is going to be taxable at resident's tax rate. why pay bank mortgage interest when you don't have to? Set aside some emergency funds (in a high interest bank account like BankWest Telenet) to last you 3-6 months, but anything over and above that, you should try to pay off your loan as much as possible, even if it is IP and you get tax deductions on the mortgage interest.
live below your means and try not to redraw, and listen to Dave Ramsey on iTunes' daily podcast for some interesting thoughts on debt.
Great strategy if cashflow and positive gearing are your thing, counter productive if your strategy is negative gearing…
Also, kyla has a fixed interest loan, which will only allow them to pay a certain amount extra before they incur fees.
tax deductibility of interest paid on your investment loan depends on what marginal tax rate you are on.
for an example : if you are on 40% you lose say $1000 to get $400 back on tax
if you use an offset account you save $600 in interest costs taking the $400 tax rebate into account .
Even if it was a positive cash flow the tax is $400 so you are up $200pls don't take this the wrong way as i am genuinely asking a question here. in the situation that kyla raised, is strategy to negative gear even make sense? putting aside other factors like capital growth, depreciation, etc., if i have $10k extra cash, then i would pay off the mortgage rather than do anything else with the money (of course, it is correct to mention about maximum amount allowed to overpay the fixed rate loan until you incur a fee).
the property already exists, the loan already exists….what to do with $10k is not going to change the capital growth structure, depreciation schedule, etc. why stick with negative gearing and pay 70% of your money to get the other 30% tax benefit?
tax rates come into play obviously, but also interest rate difference between kyla's fixed rate vs high interest bank account.
ultimately for me anyway, if i have $10k lying around, people tend to find ways/excuses to use it, so might as well put it somewhere they can't touch and don't feel the urge to go and spend.
I actually agree with you JRr, but we're obviously in the CF+, debt is only good if someone else is paying it group
Different mindsets and different situations, neither being incorrect, just different.What IS kyla's financial situation and what strategy has she decided upon? Without knowing this I thought it best to put as many cards on the table…
As duckster has demonstrated, paying down the loan CAN be beneficial in a CF- situation, also demostrating just how important it is to have a clear idea of your own financial position and your objectives before jumping in to the investment game.
My situation is different again, as is my structure so I would do things differently again
Completely agree. May be I was too fast to assume Kyla's "situation", so I am sorry there as I do respect people to put options out of the table.
As for different situations, we are actually doing the complete opposite to what I suggested to Kyla. But that's because our situation is very different (at least we think it is, better not assume again!). We are expats living outside Australia and we only pay 10% withholding tax on interest income earned in Australia. So for us, we put all our cash in the bank account earning 8%+ and keep the investment mortgage as high as possible to benefit from negative gearing. Obviously we can't use the tax losses each year and we just accumulate it, while in the meantime remaining cash flow neutral.
See, I had your situation wrong all over
and mine is completely different Kyla, care to divulge any further re your situation, stragey etc?
thanks for all your comments and advice!
Im new at this so my knowledge is fairly basic! i guess our plan and strategy was to get into the property market while it was a good time to buy as well as reduce our taxable income (my husband is in the 40% margin and im in the 30%). We ended up buying a unit instead of waiting until we could afford to by a place suitable to actually live in, in the same area. So now our aim is to buy a PPOR in 3 years time (at the earliest).Initially we were planning to make extra repayments inorder to build equity so the loan for our PPOR won't be as big. But then i thought we could redraw the extra repayments and use that as a deposit. However now i realise thats not a viable option. So should we still try to build equity or put it into a term deposit account?
Thanks Kyla.
Everyone here was new at some stage (I still am) – it's all good
A couple of tips you'll see around here are Read book after book after book on the subject and learn different people's strategies and how they implement them. I also read up a lot on structures (trusts, tax etc) so that when I speak to my accountant, we're on the same page (it ends up costing less because you're asking your accountant less questions and his time is your money
.Is the property in both of your names? If so, A. You've now both lost the FHOG (I assume you knew that though) and B. here's where an accountant may have come in handy before purchasing…
If the property is in both names 50/50, I believe half the income and half the interest has to be attributed to you and your husband i.e if you pay $30k per year interest (for example), 15k has to be attributed to both of you. Now, obviously if you're looking at reducing your taxable income, having the property in your husbands name alone would have more benefit – for every $1000.00 reduced from your husban'd income, he reduces his tax bill by $400.00 if he stays in that bracket. You only reduce yours by $300.00. Of course that would have been dependent on one of you being able to service the loan individually, so it may not have been relevant…
You CAN redraw the extra deposits you make, but the interest incurred on the investment loan by the redrawn amount won't be deductible so take this into account when deciding. Of course the advantage is you've effectively earned the same rate of return as your mortgage interest rate tax free by saving that much. Also, make sure you do your sums before contributing extra, as this will (perhaps permanently) affect the ability of the loan to reduce your taxable income – the less interest you pay, the less you reduce your income by.
We can theorise all we want here, but you really should speak to an accountant and / or financial advisor before going either way
imugli made a good point, if you pay off loan balance (ie. building equity) in the investment loan account, when it comes time to redraw to buy PPOR, the "future" mortgage interest on that same portion of the investment loan is no longer tax deductible, in the eyes of the ATO. So if you plan to buy a place to live in over medium term, then probably best to deposit into a high interest bank account.
i am always about trying to stay cash-flow positive or as close to neutral as possible (in the case of being negative), so you do want to choose a place to park your cash that gives you t a fairly high interes rate, like term deposits with Bank West or Techer's Credit Union (they do allow non-members to open up term deposits with them). but like imugli says, get an accountant / financial advisor. generally, your gains should outweigh the fees they charge in the long run.
For what you want to achieve the property should have been purchased as Tenants in Common and the additional funds should be placed in a high interest bearing account.
Richard Taylor | Australia's leading private lender
Thanks everyone! I think we will end up having to put the funds in a term deposit account. We should probably hit the book shops this weekend too! Actually imugli, i made some enquiries with the NSW office of state revenue before we purchased the unit and apparently, if we never reside in the investment property, we are still eligible for the FHOG when it comes time to purchase our PPOR… i was pretty surprised to hear that actually, i dont think many people realise it.
Kyla
Yes that is correct if you have never purchased a PPOR before and dont reside in the IP you are certainly entitled to the Grant.
Wont get any State Stamp Duty concessions but will get $7K or so to kick around.
Richard Taylor | Australia's leading private lender
Hi Kyla
A bit late on the scene with this one, just remember that in the end it as about accumulating NET wealth in the most efficient way based on YOUR situation.
Over time it is about reducing reliance on your personal exertion (work) income to fund the lifestyle you desire.
When borrowing to invest be careful not to become a slave to the arrangement requiring added pressure to produce more personal exertion income depending on the income performance of the investments – the debt has to be serviced by some sort of income (not capital growth that can't be accessed until you sell the investment).
I see you are on two incomes, plan your future decisions on whether both of these incomes will always be available (eg time off work to have a family – if this is in the plans). I'm sure Richard (QLDS007) would agree, this is where things can come unstuck if there is too much debt reliant on the second income.
The other one to consider is using "income protection insurance" to protect your debt servicing ability – negative gearing relies on income from both of you, if that isn't there then there is problems. This is not mortgage insurance – it is sickness and accident insurance – beware to get a quality product.
Best wishes with the project – you have done well to get where you have so far.
Hello Kyla
After 2 years, when your fixed loan period expires you would naturally organise an offset account for the loan and move the $10,000 into there.
Actually if you sit down and work it out you'll see that it will only cost you an extra $200 – $300 in total over the 2 years that the money is in a high interest account instead of reducing the interest on your loan.
It's certainly not worth reducing your tax deductible interest for that as this will continue for the life of the IP loan.Cheers
Elka
and mine is completely different 
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