Hello All,
Long time lurker first time poster.
I have tried searching for the answer but am not having a lot of luck other than finding Richard's excellent suggestions re: using a LOC to fund 20% deposit (and costs) of purchasing an IP.
My question is Does the bank allow the use of a LOC to pay the INTEREST componant on an IP interest only loan?
Based on that it's has been suggested to me you could pay down your PPOR faster by:
- Borrowing 100% of value and costs for an IP interest only
- Taking LOC to the tune of $100k or thereabouts
- For the first 12 months the rental return of the IP goes fully onto your own mortgage to pay it down faster
- The LOC is used to pay the *interest only* cost of the IP plus other normal expenses (rates etc etc)
I've played this out on my own scenario:
- $500k PPOR with $140k owing with $400per week minimum payment (we're paying considerably more currently)
- Purchase IP of $480k (plus costs) returning $650pw
- LOC of $50k
- 100% Rent goes to my PPOR mortgage paying it out in approximatly 12 months
- The LOC grows to around $42k in that same time ($30.3k interest and $11k of expenses) with a min repayment of $52 per week at an inflated rate of 6.40%
- So I have gotten rid of a minimum $400 per week (PPOR) and replaced it with $52 a week (LOC)
Sorry for the explanation if it isn't very clear, but is it something that works/kosher? Dangers, issues, etc? Does the bank allow the use of a LOC to pay the INTEREST componant on an IP interest only loan?
Glennsa
I don't have a LOC but have a redraw facility for my PPOR and investment property — payment over and above the required P&I (for PPOR) and Interest (for IP) are available for me to take out at any time and the bank does not know for what purpose I use the money.
In your case, your bank has agreed the LOC, whatever amount in your LOC is yours to use. I can see no restriction on how you use your LOC, unless the bank has imposed the restriction before hand.
Cheers.
Hi Glennsa,
I work for a Bank, and I cannot see any Bank having a problem with that. As long as you stay within your approved limit for your LOC then you will be fine.
The only other thing worth considering is that I believe it can affect you at Tax time somehow…. I will leave it to one of the taxation experts to fill you in on any possible downside on that part of things – but as far as the Bank is concerned that is not a drama!
Good luck!
Cheers,
Matt.
Thanks for the replies, Proasset and Matt.
In theory it all looks to be gold – an IP at zero out of pocket costs for the first 12 months with a more than serviceable debt at the end which can also be refinanced into the IP as its capital grows over the next few years (making some assumptions about growth of course).
Mentally my sticking point is using the LOC to pay the interest of the IP loan sounds like using one credit card to pay off another, and because I haven't bought an investment property yet – or used a LOC or an overdraft – it seems suprisig a bank would allow it to be used that way.
But I take on board what you both have said breaking it down to its most simplest terms – if the bank has approved it, and you can service it, what is to stop you drawing it out and p!ssing it away in a night at the casino. Same same.
Glennsa
I have written a few posts about this.
Once a lender give you a LOC you can use it as you please. But you had better be careful about the ATO considering this is a scheme set up to avoid tax. You need a good accountant to set it up for you and you need to be doing it for a reason other than saving tax. probabaly best to get a private ruling.
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 for the reply, Terryw.
Certainly not looking at it from a tax avoidance perspective, solely from a paying down my PPOR as fast as possible perspective. I'll have a look through your previous posts as I am wanting to get as much information about this as I can. Thanks again.
p.s. for the record we will have everything going through an accountant (recomended by a couple of property investors I know personally) who specialises in property investments.
Glennsa
As an update my bank finally got back to me. I was asking a question about interest only property loans and whether we could make additional payments if we wanted to. The answer was as long as on a variable rate (not a fixed contract) then no problem, just nominate the account you want the interest to be deducted from as a minimum and make any additoinal payments when you choose. That allowed me to segue nicely into asking if a Line of Credit could be the nominated account to which the answer was "Yes, a lot of people do that. As long as you don't exceed your approved LOC limit that will be fine."
So getting good confirmations on it now which is allowing our minds to rest a little easier. We're meeting with the accountant in two weeks so we will definitly ask the tax deductability questions.
Glennsa
Hmm very interesting, will be keen to hear Richard's view on this? Richard has just helped me set up a LOC with my existing lender of 50k which I will use to purchase my I.P I am buying off the plan.
By the way guys I cannot speak highly enough of Richard (QLD007) and the A+++ advice he has giving me so far in the setting up and structuring of my loans.
Firstly thanks very much Andrew for the wrap its a pleasure as you now.
Terry is correct whilst some lenders will insist there is a repayment made on the LOC others will allow the interest to capitalise.
As long as it is not perceived that the loan was set up purely as part of a Tax avoidance scheme i cannot see an issue in this as part of a debt recyclying plan.
Would need a wee bit of careful planning to establish it correctly in the first place.
Richard Taylor | Australia's leading private lender
Thanks for the reply, Richard. It was your posts I was referring to re the LOC for the 20% deposit.
For this first one we are looking to be mortgage free on our PPOR in 12 months and certainly for future IPs your advice is something we will look at very very serisouly.
For what it is worth, have fired just now fired off what will hopefully be a final offer on an apartment we have been eying off. Wish us luck!
Look at the latest flash at http://www.bantacs.com.au. They have a private ruling on capitalising interest
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
Glennsa I think it is a very creative idea that you have – at the end of the 12 months essentially you will have turned a $140k mortgage into a $50k line of credit, is that right? You would still be paying off your usual repayments, plus the rent from investment property?
I am new to this and trying to make sense of things, I think it sounds like a great idea provided you had the equity for line of credit which you do.
Thanks for the link, Terryw. While I appreciate it is a private ruling it is still further information that it is a valid strategy.
I would be interested in a basic explanation of why it could/would be seen as a tax avoidance scheme – or is it because you're paying down your own mortgage some people wouldn't then claim the rent as "income"…?
Sophieh, I can hardly take credit for the idea, but it does seem creative. To modify your detail slightly:
at the end of the 12 months essentially you will have turned a $230k principle and interest mortgage with $140k balance into a $50k interest only line of credit, is that right?
So in our case, yes. I think it would work well for people like us whose mortgage end date through additional repayments is reasonably close already (say less than three years). By working a little out of the square instead of just being mortgage free on the PPOR – which in itself IS a good thing – we could be mortgage free on the PPOR and have an IP well underway in the same time, if not sooner.Glennsa
Sounds like you have heard of the Harts case. Many years ago a lender set up a loan product which was split into 2. One loan for for the investment property and the other for the home loan. The borrower then put all money to the home loan and all the interest on the investment loan capitalised.
It went all the way to the high court who ruled it a 'scheme' to reduce tax and it was done with that dominant purpose.
Interestingly in one of the judgments one of the justices said that capitalising interest was acceptable and he implied that it would have been ok if they have gone about it differently.
One of the main things that worked against this product was that it was marketed as a way to save tax and it was a single product set up for saving tax.
So you need to be very careful when setting up your loans. Ideally you should have the investment and the home loan at different banks and maybe have all the income and rents paid into a 100% offset account instead of into the loan. Also have a plan on how the investment loan is going to be reduced to $0 in x years. All this will strengthen your position if the ATO challenges it.
The Harts case is now authority for the definition of a "scheme".
have a read at (not an easy read either):
http://www.austlii.edu.au/au/cases/cth/HCA/2004/26.htmlAn easier article:
http://www.smh.com.au/articles/2004/05/28/1085641713197.html?from=storylhsSee also this from the ATO
http://www.ato.gov.au/individuals/content.asp?doc=/content/45127.htm
They say the Hart case only applies to split or linked loans.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 for the information, Terryw. The legalese is starting to do my head in, but I think I understand the "issue" is that when they were capitalising their interest, they were claiming a deduction on not only the interest from the IP loan, but the interest on the interest in regards to the Line of Credit – so a double dip as it were. Also implications that by paying off your PPOR and rasiing a LOC to the same amount you could be seen as trying to transfer your non-tax deductable debt to a tax deductable position.
Am I at least half getting it?
Glennsa
Glennsa
Yes you are getting there.
Richard Taylor | Australia's leading private lender
it feels risky,
if you can pay 140K off in 12 months or so with the addition of 650 week (35K pa) then you would have you PPoR paid off in < than 2 years so I would probably not push my luck with the ATO.
mxd wrote:it feels risky,if you can pay 140K off in 12 months or so with the addition of 650 week (35K pa) then you would have you PPoR paid off in < than 2 years so I would probably not push my luck with the ATO.
Some have private binding rulings. Its worth a try with a ruling I think
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 Terry & Richard, I really appreciate the time you have given me.
mxd, when I first heard of how this is supposed to work I thought it was risky as hell, primarily because I didn't know then what I know now. That's why I have been asking the questions and doing as much research as I can. In my more educated (although not professional) opinion, I feel a lot more comfortable moving forward with this. Sure we could wait another two years, but that may well mean lost oppurtunity in regards to property we could invest in given the equity.
Glennsa.
Glennsa wrote:Thanks for the information, Terryw. The legalese is starting to do my head in, but I think I understand the "issue" is that when they were capitalising their interest, they were claiming a deduction on not only the interest from the IP loan, but the interest on the interest in regards to the Line of Credit – so a double dip as it were. Also implications that by paying off your PPOR and rasiing a LOC to the same amount you could be seen as trying to transfer your non-tax deductable debt to a tax deductable position.Am I at least half getting it?
Glennsa
I think capitalising the interest the LOC would be ok (see TD 2008/27, The principles governing the deductibility of compound interest are the same as those governing the deductibility of ordinary interest). The main problem with it was that it was one product set up secifically to reduce tax – with no other pupose.
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
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