# Debt recycling with a P&I loan

Discussion in 'Accounting, Tax & Legal' started by goponcho, 12th Dec, 2019.

1. ### goponchoActive Member

Joined:
4th Nov, 2017
Posts:
44
Location:
Perth
Hi guys,

Trying to decide between if using a P&I loan is better, as it 1% cheaper than IO. However, we will end up paying down some of the loan and so our deductible loan will reduce in size. I am trying to work out a way of using a P&I while maximising our deductible debt.

Say we had a \$1,000,000 owner occupied home loan that we wanted to debt recycle.
We then split into say \$100,000 split using a P&I loan at 3%, pay this down, then redraw it out to buy income producing shares.

1) My question was with whether we can continue to redraw any amount paid down into this P&I loan??
Say for example, after 5 years due to our repayments, we have paid down our loan to \$90,0000 so have \$10,000 in equity. Can we merely redraw the extra \$10,000 and use this to invest? And then our deductible component will return to \$100,000 in order to maximise our deductible debt?

2) How frequently can we redraw our equity? Theoretically can we pull it out every month as we pay our interest repayment, so technically keeping the loan always at 100% of original loan??

Thanks!!

twisted strategies likes this.
2. ### goponchoActive Member

Joined:
4th Nov, 2017
Posts:
44
Location:
Perth
All good worked it out!!
Using an interest rate calculator found over 5 years prior to refinancing, approx 10% of the loan is paid down in a P&I loan of 30 years.

So looked at two options to simplify things with estimated interest costs on \$100,000:
1. Interest cost IO (IO, 100% deductible loan @ 4.13% @ 39% marginal tax rate) = \$100,000*4.13%*61%=2519\$
2. Interest cost P&I (P&I, 90% deductible loan @ 3.13% @ 39% marginal tax rate) = \$90,000*3.13%*61%+\$10,000*3.13% = \$2031

So P&I at these rates superior, plus might be able to use some of the paid down equity in the interim to increase our deductible loan further.

Thanks me!

twisted strategies likes this.
3. ### twisted strategiesWell-Known Member

Joined:
3rd Nov, 2013
Posts:
1,323
Location:
QLD
good one !!

this was well outside my skill levels so i wasn't going to be any help , sorry

may everything go well

cheers

goponcho likes this.
4. ### HodorWell-Known Member

Joined:
17th Sep, 2016
Posts:
314
Location:
hodor
It should be obvious you are paying less interest with a lower interest rate. P&I vs IO in this type of scenario is a question of cash flow as the principle repayments increase your repayment.

Depends on the conditions of your loan etc, you can possibly re-borrow the repayments.
Getting a loan to reduce tax shouldn't be your primary motivation, you are getting a deduction because you are losing money - although the investor is trying to get returns in excess of the borrow costs.

twisted strategies likes this.
5. ### goponchoActive Member

Joined:
4th Nov, 2017
Posts:
44
Location:
Perth
Thanks for the reply, it's just a standard re-draw loan. Hopefully as default you can, will ask bank manager later on.

Good point about the repayment amount being higher with the P&I too for cashflow concerns. Not constrained by cashflow currently so didnt mention it.

Our primary motivation is to increase equities exposure aiming for a positive expectation, however debt recycling minimises the incidental costs such as interest. Not just for the deductions as sometimes people do

twisted strategies likes this.
6. ### TerrywWell-Known Member

Joined:
9th Jun, 2006
Posts:
957
Location:
Sydney

twisted strategies likes this.
7. ### TerrywWell-Known Member

Joined:
9th Jun, 2006
Posts:
957
Location:
Sydney

twisted strategies likes this.
8. ### TerrywWell-Known Member

Joined:
9th Jun, 2006
Posts:
957
Location:
Sydney
1. No as the loan will amortise over 30 years to the 'limit' will constantly decreasing over time. Th above diagram will show how much would be available for redraw

2. No limit. You could potentially do it daily.
One trap though is some lenders do not allow immediate redraw. If you deposit into the loan you will only be able to get the money out after the next monthly repayment.

twisted strategies likes this.
9. ### TerrywWell-Known Member

Joined:
9th Jun, 2006
Posts:
957
Location:
Sydney
twisted strategies likes this.
10. ### goponchoActive Member

Joined:
4th Nov, 2017
Posts:
44
Location:
Perth
Hi Terry, not sure what you axes represent?
But so slowly at first, and faster later the limit that we can redraw declines?
Not too much of a decline in limit, if we have to refinance after 5 years i think.

twisted strategies likes this.
11. ### goponchoActive Member

Joined:
4th Nov, 2017
Posts:
44
Location:
Perth

twisted strategies likes this.
12. ### TerrywWell-Known Member

Joined:
9th Jun, 2006
Posts:
957
Location:
Sydney
Time on the bottom one and outstanding loan on the side one.

This sort of graph would apply for someone keeping some extra cash in the offset account and/or paying a bit extra per week into the loan.

twisted strategies likes this.
13. ### goponchoActive Member

Joined:
4th Nov, 2017
Posts:
44
Location:
Perth
Practically speaking with regards to jointly withdrawing from a split P&I loan and lending to a trustee, how does this work.

Say i split \$250000 at 4% P&I and I then onlend (with a commercial loan agreement) to the trustee with interest rate equivalent to 'loan from bank X'. Please note as it is P&I the interest component is slowly decreasing with time.

Say in the first year my personal interest is \$1000 principle, \$9000 interest. I would also personally receive \$10,000 from trustee for interest. Since i loaned the money, i have made a profit of \$1000 which i must pay tax on?

Next we look at the trustees position. Their total interest payment is \$10,000 for the year, of which only \$9000 is deductible for the trust?? Or is the full \$10,000 deductible? The trustee did borrow the full \$10,000 for investment purposes....

Hope the example makes sense.

twisted strategies likes this.
14. ### TerrywWell-Known Member

Joined:
9th Jun, 2006
Posts:
957
Location:
Sydney
Only interest is income, not principle. You won't be making a profit. The trust could only claim interest as a deduction, not principal.

Imagine your self borrowing \$100,000 from a relative interest free. If you give them back \$10,000 per week this is not income but a return of what you borrowed.

twisted strategies likes this.
15. ### goponchoActive Member

Joined:
4th Nov, 2017
Posts:
44
Location:
Perth
Hrmm
Does that mean the loan from individual to trust be a P&I too? I think the commercial loan needs to be paid off in 7 years as far as i remember. How does the duration differing between the loans (30y vs 7y) effect it?

Let me try an example.
Year 1
Loan by individual repayments \$9000 interest \$1000 principle
Loan by trustee repayments \$10 000 deductible?? As whole thing was for investment purposes??? Or would it be \$9000 interest, \$1000 principle repaid

Alternatively, can the loan from personal to trust be interest only?? If the loan agreement is for example interest rate equivalent to 'loan from bank X', could it just be pay 4% pa for 7 years, then pay principle back at end of period?

On another note have been doing some trudging through somersoft (Loan agreement between trust & individual)
As the loan from personal to trust is unsecured, reflecting the same interest rate is probably not on commercial terms, can just add a % or include a personal guarantee?

twisted strategies likes this.
16. ### TerrywWell-Known Member

Joined:
9th Jun, 2006
Posts:
957
Location:
Sydney
The loan to the trust could be PI or IO. You could borrow from the bank as IO or PI = doesnt need to match.

No need for a 7 year loan. You are thinking of Div7A loans possibly, these apply to borrowing from a company or a trust with a UPE to a company.

Only interest can be deductible.

I obtained a private ruling for a client who onlent unsecured to a trust at the same interest rate that he paid to a bank. You can't rely on it, but the ATO has allowed it for at least 1 person.

twisted strategies likes this.
17. ### goponchoActive Member

Joined:
4th Nov, 2017
Posts:
44
Location:
Perth
Oh okay i didnt realise that. Thanks!
So if the loan the trustee is IO, the loan that the individual is taking out is completely irrelevant to the trust?

If the trustees loan is IO, the whole interest payment is tax deductible
If the individual's loan is P&I, only the interest is deductible, and only that corresponding % of the interest received is deductible? ie 90% in first year and will reduce each year as more principle is paid.

As the loan is from an individual(s), does it still need to be on commercial terms then? Is there somewhere to read up on any restrictions on this loan - cant seem to find much on the ATO site

twisted strategies likes this.
18. ### TerrywWell-Known Member

Joined:
9th Jun, 2006
Posts:
957
Location:
Sydney
the loan will need to be on commercial terms if interest will be claimed.