Hi All,
Great forums, I've been a reader for a while. I'd really appreciate your advice on where I should head next if you have a moment.
Current personal income: $70k-$100k, former PPoR value:~$500k (3 yr old 3 bed modern townhouse in a central metro location), owes $293k (st george variable P&I). ~$107k accessible cash equity if I decided to open a LOC. Now happily rented to a professional couple at $510/wk. It's breaking even and currently covering all costs, including body corporate and land tax. So that one's virtually looking after itself now and just sitting there. The townhouse is also best kept as an investment because it's new and therefore decent depreciation to be claimed. I'm moving cities and don't want to move back into it.
But of course I now don't have a PPoR to live in. I want to get a cheap house (~$250k) to live in and possibly renovate for growth. I want to keep my mortgage small on this next one with the aim to just pay it down ASAP, so that I can end up with a debt-free PPoR and also add some value from renovations. I have the luxury of being able to live for 1 year rent-free next year in my parents' place to look after it for them while they travel – I want to use that year as wisely as possible.
Questions:
– With the townhouse, is it best to leave the loan as P&I? The idea of it gradually paying itself down over time sounds appealing, but is there more to this and is it actually smarter to NOW have smaller loan repayments via an I-only loan and that then frees up more surplass income for buying more property. Any thoughts on this? As the property is only kind of *just* breaking even, I probably need to be better shielded from future rate rises, so therefore, leaving it as a P&I loan is the smartest??– Does setting up the $107k LOC as the deposit to buy the next ~$250k PPoR seem like a wise move? Then I just move into that new PPoR and focus all my efforts on paying that new debt down ASAP. Can the funds drawn from that LOC be claimed as part of the townhouse's investment property loan? Or are there any tricks or techniques to doing something clever here?
Many thanks for any obvious pointers or wake up calls etc.
It is best to change the loan to Interest only asap. Each dollar you pay means a dollar less for your new home which means more non-deductible borrowings. Set up a 100% offset so it will save you the same interest as if you were paying down the loan.
Yes, set up another loan for the deposit, but probably not a LOC, just a IO loan will do as the LOCs have a higher interest rate. Try to keep this loan to 25% of the new property to cover the deposit and 5% costs. You can't claim the interest on this as it is not for investment.
Then, a small 'trick', set up another loan a 3rd loan on your townhouse. Use this loan to pay for all expenses for the investment property. ie borrow to pay for expenses and claim the interest. The cash that you would of used can then go to your home down to pay down non-deductible debt.
Terryw | Structuring Lawyers Pty Ltd / Loan Structuring Pty Ltd
http://www.Structuring.com.au
Email MeLawyer, Mortgage Broker and Tax Advisor (Sydney based but advising Aust wide) http://www.Structuring.com.au
Many thanks Terry – greatly appreciated.
Can you please just clarify a few further questions?
So the tennants' rent goes directly into the offset account. So the result is that I am being charged the same interest, yet I can claim more each tax time because the official "loan" remains higher on paper. Then also, I have better access to the cash for the next PPoR purchase because it's just sitting there in the offset? Note: as the property is only just breaking even, I guess it will be a while before that amount adds up to anything substantial.
Also: Re: changing to an I only loan, I understand this will free up more cash in the short term, because the repayments will be less, yet I continue to be able to hold onto the property. So this "extra free cash" can then go into the new PPoR property? I am a little hazy here. Oh I'm allowed to use the excess rent to pay my own mortgage off BECAUSE I would be paying the rent into an offset, INSTEAD of directly into the existing investment mortgage..? Is that the logic here? Therefore, I can now start to use any excess of rent coming in to fund my own PPoR mortgage, while leaving the investment mortgage sitting idle and just paying off the minimum repayments of the I-only loan basically…
Also, so the other loan for the new deposit, is just pulled again from the townhouse's existing $107k equity? Does it make any difference if I pull back on that equity vs getting a brand new fresh loan? And what's the reasoning behing keeping the new deposit loan to approx 25% of the new house's value?
Thanks once again Terry.
I think you have it slightly squewed.
Lets work thru some rough figures.
Your current loan is $293,000. I recommending changing this to IO for many reasons – the main one is taxaxtion. eg may explain it better:
Say you had $50,000 in savings. You could deposit this on the loan (plan A) and the balance will be $243,000. Or you could put it in an offset account (plan
and you loan balance will be $293,000 but you will only be charged interest on $243,000. So the net interest is the same either way.A year down the track you want to buy a new place to live in. Plan A above would mean your money is tied up in the investment. To access it you would need to use redraw and this will be classed as new borrowings. The interest on this extra $50k will not be deductible as it was borrowed to purchase a new place to live in.
If you used plan B the loan balance has not changed. You will take the $50k from the offset, not the loan. This is not new borrowings. The interest on the loan will now be charged at the full loan balance of $293,000 and your tax deductions will increase. You have effectively gained a tax deduction on this extra $50k borrowed.
This is why you should never pay down a loan, especially one on an investment.
In addition you get all the rent and wages paid striaght into the offset so you are saving even more interest. When you buy the new place to live in you take all the money with you and set up a new offset on this house so you can save non-deductible interest and maximise tax deductions on the old investment.
Taking this one step further.
Your IP value is $500,000. 80% of this is $400,000, but current loan is $293,000 that is a potential $107,000 LOC. You could use this to purchase the new one, but I recommend doing it differently.
You want a new one around $250,000 so you will need 20% deposit (to avoid LMI) and 5% costs = $62,500. So have this as one split. maybe round it up to $65,000. The remaining 80% comes from a new loan, also recommend IO wth offset.Then have another $42,000 as a LOC and use this for all expenses relating to the investment property. Borrow to pay rates, water, insuruance, etc. The money you would have used to pay can then go to your new PPOR loan.helping to pay it down faster. If you had more equity you could even apply for a private ruling and have all interest for the IP loan paid for out of the LOC making it even faster.
Terryw | Structuring Lawyers Pty Ltd / Loan Structuring Pty Ltd
http://www.Structuring.com.au
Email MeLawyer, Mortgage Broker and Tax Advisor (Sydney based but advising Aust wide) http://www.Structuring.com.au
Thanks once again Terry. That was again very helpful.
The offset vs redraw tax advantages now seem very clear.
So to check my understanding, is this correct:
The essence of changing to an IO loan, is that the repayments are smaller than for a P&I loan. This means that each month, I will be left over with more spare cash from the rental income. This spare cash can then be used (via the offset account) to help reduce my new non-deductable mortgage. And that makes sense because you want to shrink any non-deductable loans ASAP where as a deductable mortgage is fine to just sit there, because it's deductable. So you are essentially diverting money that would have just been reducing an already deductable P&I loan into helping to pay down a non-deductable loan?Meanwhile however, your investment loan just sits there forever, is that a good thing? Or because that debt is deductable, AND the place is appreciating in value, it doesn't matter.. I.e. you will make your money from the capital gains, not from paying the deductable debt down.. Am I on the right track??
Now re: the new PPoR loan. Why should that be IO? can understand not wanting to pay investment debt down, but with your PPoR, don't you want to pay it down super ASAP? Or is your approach leaving it as IO, so that you can essentially build up cash in an offset against that IO, then when you have enough cash eventually in that offset which matches the balance of the IO loan, you have essentially paid the loan off, but then LATER should that house then later become an investment, well it's still "officially" in debt, because you never really paid it off, you just saved into an offset.. I think I am starting to follow you here..
Many thanks!!
What starts as a PPOR has a habit of becoming an IP and therefore where possible would always recommend a Interest only loan with 100% offset.
Regretfully too late in 3 years time when you decide to move again and want to retain the current PPOR as the next IP.
Flexibility is key to loan structuring something which i think Bank managers and a lot of mortgage brokers have absolutely NO idea about.
Re-read Terry's post as he makes some excellent and valuable comments.
Richard Taylor | Australia's leading private lender
c9806103 wrote:Thanks once again Terry. That was again very helpful.The offset vs redraw tax advantages now seem very clear.
So to check my understanding, is this correct:
The essence of changing to an IO loan, is that the repayments are smaller than for a P&I loan. This means that each month, I will be left over with more spare cash from the rental income. This spare cash can then be used (via the offset account) to help reduce my new non-deductable mortgage. And that makes sense because you want to shrink any non-deductable loans ASAP where as a deductable mortgage is fine to just sit there, because it's deductable. So you are essentially diverting money that would have just been reducing an already deductable P&I loan into helping to pay down a non-deductable loan?Meanwhile however, your investment loan just sits there forever, is that a good thing? Or because that debt is deductable, AND the place is appreciating in value, it doesn't matter.. I.e. you will make your money from the capital gains, not from paying the deductable debt down.. Am I on the right track??
Now re: the new PPoR loan. Why should that be IO? can understand not wanting to pay investment debt down, but with your PPoR, don't you want to pay it down super ASAP? Or is your approach leaving it as IO, so that you can essentially build up cash in an offset against that IO, then when you have enough cash eventually in that offset which matches the balance of the IO loan, you have essentially paid the loan off, but then LATER should that house then later become an investment, well it's still "officially" in debt, because you never really paid it off, you just saved into an offset.. I think I am starting to follow you here..
Many thanks!!
Yep, I think that is about correct.
As for investment loans being paid off – I would never pay one off, but just leave them IO and pay off the PPOR first (or offset). Once that is done then you could start paying off the investment loans, but I would just set up an offset on one of these and accumlate funds there.
Remember once you have paid down a loan there are tax consequences of getting the money out again.
Terryw | Structuring Lawyers Pty Ltd / Loan Structuring Pty Ltd
http://www.Structuring.com.au
Email MeLawyer, Mortgage Broker and Tax Advisor (Sydney based but advising Aust wide) http://www.Structuring.com.au
Many thanks again Terry. Your advice has been awesome.
Also thanks Richard, what you say re: PPoRs having a habit of becoming IPs makes good sense too, and is a path that I would be likely go down for sure.
Now a little further down the track… I get the place for $250k, renovate it and wait 3 years, then it's worth maybe $350k. I might have accummulated say $50k in the new offset account for that PPoR. All of a sudden that house may be able to pull in $350/wk in rent and the debt is down enough (virtually, because of cash in offset) so it will break even. So I look to turn it into an IP, because at the same time, my family has grown and I want to upgrade our PPoR.
How the hell can you then keep this place as an IP, but then somehow afford to go and buy a $500k home that has the size and features that you might need? Do you essentially need to wait until the rents rise up enough from your IPs, so that they can be piling excess profit each month into the IP offset accounts, and then you use that money to help pay your new HUGE PPoR mortgage
Or can it only really work if you planned to live in cheaper houses forever that would later be suited as IPs? Because I have a longer term vision, e.g. 5-10 years of eventually being in a reasonably big place as my PPoR. But if I keep moving out of smaller PPoRs and turning them into IPs, how do I accumulate any capital that can be rolled in to purchase the big PPoR?
Hope this makes sense.. Or do you basically have to "cash in" and sell investment properties to then be able to move into your dream home?Awesome helpful thread
Sometimes selling can make sense, especially if you have huge equity in an IP and you can use that to pay off your PPOR.
But other than that you can afford to buy a new PPOR if your income and rents are high enough. Don't forget that rents helps servicing a lot.
Terryw | Structuring Lawyers Pty Ltd / Loan Structuring Pty Ltd
http://www.Structuring.com.au
Email MeLawyer, Mortgage Broker and Tax Advisor (Sydney based but advising Aust wide) http://www.Structuring.com.au
Ok so the general idea is that while accumulating IPs, hopefully your personal and rental incomes are both generally increasing along the way. Then you can use the excess of rental incomes via the offset account(s) to help knock down your PPoR mortgage.
Thanks once again for wrapping that up Terry.
and you loan balance will be $293,000 but you will only be charged interest on $243,000. So the net interest is the same either way.
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