Can someone translate this strategy in laymans terms.

Tailcat said this in voigstr's thread.

What is the problem????

Suppose you have $100k PPOR and $50k IP in the same account. If you make a repayment of $150 (not an interest repayment) then ato says that $50 must come off the IP. Then:

Deductible interest changes next month
You have lost deductible interest (it will mount up...)

If you then spend the $150 dollars, for food say, you have converted $50 into bad debt.....

Solution.....

Use two separate accounts (held against the same PPOR house)!!!!!

A1: $100k with offset
A2: $50k IO

Pay $150 into offset account. All the money works on the bad debt. Spend the $150 on food, you still have $50k of good debt. Interest for the $50k account can be paid out of either of the other accounts. (Side benefit : your deductible interest payments are automatically recorded for you on your statement....)

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I've been trying to wrap my head around the concept/benefit here... Could someone explain it to me in REALLY REALLY REALLY REALLY basic terms, perhaps give a scenario...

Thanks guys.

 

Tailcat's description is good, I reckon, but let me see if I can break it down (yo) for you...

Let's say you have one loan, eg your main mortgage against your PPOR with $200k owing, and you've built up a bit of a buffer, say $20k. You decide to invest that $20k in a MF (or any other income-deriving investment).

Now you're happy, you have your investment nest-egg started, and you continue to put your leftover pay each month into the home loan to reduce the balance and pay it off quicker. And then the MF does the righty and pays you a distribution of $500, so you chuck that into the loan as well.

Unfortunately, the ATO does not generally let you decide that the money that you put into the loan is directed solely to the PPOR bit, instead you (generally) have to 'apportion' the money (spread it across the two parts of the loan: the non-deductible and deductible bits).

But this is bad for you, since you want to selectively pay off your 'bad' (non-deductible) debt - ie your PPOR loan - and leave you 'good' (deductible) debt in there so that you can claim a lager tax deduction (since the investment debt is tax deductible, whilst the person/PPOR debt is not).

So how do you separate your loans, so that the tax man can see that you're paying off your 'bad' debt? The simple answer is to have a separate loan account, solely for investment purposes. This is a 'line of credit' or 'equity loan'.

The 'offset account' that Tailcat describes is just a savings account that is linked to the PPOR loan. The term 'offset' indicates that the balance in that account is subtracted from your PPOR loan before the PPOR loan interest is calculated, eg $180k PPOR loan, $5k in offset account => interest is calculated on $175k.

But don't let an offset account get you confused - just think of it like an easy-access part of your PPOR home loan. The last thing you want to do is think that if it's in the offset account, it's there to spend.

In a nutshell? Keep your personal (bad debt) separate from your investment (good) debt; the safest and most tax-effective way is to have separate loan accounts. And the last bit, as described by Tailcat? Well by having them seperate, it's really straightforward at tax time to calculate your investment interest (ready to deduct it from your income!) because your bank statement will say something as simple as, "Total interest for this account July 1 - June 30 = $xxx" (viola).

Hope this helps. I would have like to have made it shorter for you, but I had to make some points clear.
- Rod

 

Rob_WA,

Thanks for the double team.

I find it helps (the reader) to get the same thing explained by different people. Every writer makes their own subtle assumptions as to what is obvious and what isn't. That's the beauty of these forums.

Tailcat

 

Rod, couldn't you just have a single loan on your PPOR that has 100% offset, Interest only and with a LOC?

Any repayments you would normally make to the "principle" can instead be placed into the offset and money can be drawn out via LOC solely for investment purposes

Am I missing something?

 

MCM,

When you make a withdrawal from the offset account, for investment purposes, you are re-exposing the original ppor money to interest charges. This exposure is as `bad' debt and hence not tax deductible.

Tailcat

 

He didn't suggest drawing it out via the offset but via the LOC.

 

Simon, MCM, ROb_WA,

Here is a classic case of making an assumption.....

In the original post I labelled account A2 as IO. I `assumed' that this was either a simple IO account or (probably more preferably) a LOC.

Apologies for any confusion.

Tailcat

 

I think I got it..!!

So rather than having your investment under the same loan as your PPOR, seperate them, so that the interest you pay can be tax deductable, because the taxman can't seperate which part of the interest you pay, is for the investment. Correct?

i.e. $200k owing on the mortgage, and 20k sitting in a linked offset account. Rather than just investing the 20k directly, you open up a 3rd loan account for investment purposes, so that the interest you pay on the investment is clearly seperate from the interest you pay on your PPOR.

And then the trick is to put all your money into the PPOR offset account, so that you can always claim the max interest back off the investment..!

And if you set the investment LOC to IO (like tailcat said) you don't pay off any unwanted principal, meaning your getting back as much as possible, whilst still paying off your PPOR..!

Is this correctamundo?

 

SPOT ON MATE!

Another great explanation by Tailcat is here

http://www.invested.com.au/2/voigtstrs-battle-plan-16632/index2.html?highlight=battle#post33216

 

Sweeeeet..! Go me!

I've written it down in my little financial plan document, which is slowly growing as I learn more and more. Come the time I have a PPOR and some investments, I'll make sure to have them seperate from eachother! Which I probably would have done anyway... But having the investment as an IO loan so you can maximise the deductible debt wouldnt have been something I woulda thought of.

Now for my next question, which thankfully isn't a biggy...

How hard is it to get a loan with a 100% offset account? (I know this may be a silly question, but im only 20 and starting out, I haven't looked to much into property just yet.)

 

If you can get a loan then the work needed to get the offset account is as simple as ticking another box.

It is quite straightforward to set up but you wont get it on the budget loan. This is why most investors usually end up on a Professional's Package type of product where you get the loan with all the trimmings and no application or monthly fees for the basic interest rate + an annual fee of $3-400 - all deductable.

Cheers,

 

I'll be making sure to speak to you when I get me loan, hehe.

Thanks for all the info.

 

This is a pretty good appraisal of what I am trying to say!!!!!!

However, I would like to point out that there are two components of viewing the effects of this strategy.

As you have pointed out, you are maximising your tax deductions by not paying down the principal on your investment loans.

Probably more importantly, is to realise the effect you are having on reducing your bad debt (and the interest payments on it). You are placing every erg of energy into reducing this as fast as possible.

Tailcat

 

And by this I take it you mean to pay as much principal off the PPOR mortgage as quickly as you can, to reduce as much interest as possible, because that interest is classed as 'bad debt'..?

And by 'pay off as much principal' I mean have the money sitting in the offset account of course, so you can have easy access to it again for investing purposes.

 

Yes.

Also note that we are keeping the PPOR debt clean as well.

This is only a concern if there is the slightest possibility that in the future you may convert it into an IP. As soon as you convert a PPOR into an IP, the original loan converts from bad debt to good debt.

However, if you were to use this account as an everyday account (instead of the offset account), then as soon as you remove $1 to buy food, it has become contaminated as far as the ato are concerned.

Moral:

Use three accounts on your PPOR!!!!!!

A1: Original IO account that only contains the (remains of the) original loan when you bought the house.

A2: 100% offset account were the day to day workings go on. This can be contaminated with personal purchases.

A3: The account which is used to buy your future investments (and nothing else).

Tailcat

 

No you're not missing anything. This is exactly what you want. The IO LOC is the key, whether it's part of a 'split loan' or a separate loan, the security is still the PPOR. I just reckon it's easier to keep separate loan accounts.

Absolutely.

Yes, but you don't have to have an offset savings account (many loans have redraw, and if this is $0 for access, then the effect is the same). In terms of 'access' to the money, it doesn't matter if it's in the PPOR loan or the offset account, because when you ask the bank to move the money to the LOC, it doesn't matter where it comes from, only where it's going.

But you've got it sorted. So good luck with your investment plan (very impressed that you're writing down your plans at age 20 - when beer and cars and girls usually absorb all spare dollars and cents).

 

Fair enough, so my point on Offset/Redraw = who cares? needs a bit of care (I live in my PPOR so I didn't take this into account).

 

Just don't mix personal and investment funds!