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Investment Property... Pay it off?

Discussion in 'Real Estate' started by Natalie, 2nd Nov, 2011.

  1. Natalie

    Natalie New Member

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    Hello all,

    Just wanting some financial advice regarding my property.

    I recently bought a property for investment purpose. I am currently living it in for 6 months in order to utilise the first home buy grant. I now plan on renting my property.

    As it stands now, the interest i will pay on my home loan is actually less that the rent I will be receiving. I am able to significantly put in more money into my loan, therefore decreasing the interest. I understand that this will mean I am positive gearing rather than negative gearing.


    This is where I am getting a little bit confused and receive different a advice.

    At the rate I am going now, I will be able to pay my loan off in about 4 years. In about 3 years I will probably want to purchase another property and actually live in it.

    So what I need to know is....

    Do I redraw and ensure that I am negative gearing, put the re-drawed amount into a savings account and then refinance later in order to maintain this investment property and then purchase a property I will live in and ultimately pay off.

    OR

    Do i just continue to pay as much as I can and then in 3 years, redraw and refinance and have the majority of the house I want to live in paid off and then negative gear the investment property.

    Either way I figured I will be paying tax on either positive gearing or interest earned from having money in a savings account.

    I think I am confused myself but ultimately I would like to own the property I intend to live in. I would like something that has less risk and is less confusing!

    Any help would be greatly appreciated!
     
  2. Billv

    Billv Getting there

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    Natalie
    Be careful because if you redraw funds and use it for a non investment purpose the interest on the redrawn funds will no longer be tax deductible.
    Your decision on whether to pay off the loan of not should be taken after considering your overall situation.
    Do you have any other investments?
    Do you own the house you're currently living in?
    What will you do with the money if you don't pay off the loan?
    A way to preserve the tax deductibility of extra funds would be to use a loan with an offset account.
    Cheers
     
  3. Terryw

    Terryw Well-Known Member

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    You are throwing money away!!!!!

    Stop paying any extra off the loan right now. Convert it to IO and set up a 100% offset account where you can put your spare cash and save the same interest.

    When you find your new home take the money from the offset and use it on that.

    This = lower non deductible debt and higher deductible which means more money in your pocket.

    If you continue doing it the way you are doing it now you will end up paying high taxes on the rents and have a high loan amount on your new home with none of the interest deductible.
     
  4. GregR

    GregR Reid Consultants

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    Natalie,
    I agree wholeheartedly with Terry, change to an IO loan with 100% offset as soon as possible, go to another lender if need be.

    If you want to purchase a property you will live in, you want to minimise the borrowing on it if possible, so the more funds you have in an offset account (essentially regarded as a savings account and your money) will help reduce the subsequent loan, interest being non tax deductible.

    Redraw does not work from the ATO perspective as it is the use of funds that determine whether it is tax deductible and redrawing funds to purchase a home does not fall into the category of tax deductibility.

    Paying surplus funds into an offset now will reduce your interest costs but will preserve the loan integrity on what will become an investment property.
    Greg
     
  5. GunnerGuy

    GunnerGuy Index & Property Investor

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    Natalie,

    The answers so far to this thread I believe are correct. To assist here is my example of what I have done. It may help you decide.

    I have one PR property. 100% loan with offset account and full of cash up to the loan amount so no loan costs on my PR. I have 2 IP's both about 75% of house value with 2 offsets full of cash up to the loan amount. No loan costs, thus positively geared and income split between my wife and I. Both low earners and thus the renatl income is taxed pretty low.

    I could pay off all 3 loans, have no debt, and wages & rental income being taxed.

    But ..... if I want to buy another property, either a new IP or a new PR I would have to get another 100% loan. With our wages quite low (or maybe deciding to take time off work) we may actually find it hard to get another new loan so what we/I do is ..... all loans are IO. Keep the loans at full loan (do not reduce the principal owed) and then if/when we want to buy we simply take all the money out of the offsets, use the cash to buy PR - thus no interest to pay and then the IP loans will be back to their original status, ie. all interest is tax deductable of the two IP's.

    Many people advise paying off their loans, but in my case I want to keep the loans and have cash in the offset so that I can get at it for anything, including buying property cash, without having to try to get another loan.
    Yes I will pay tax on the positive rental income, but I give me options for the future and not needing to go to the bank for a new loan.

    Gunnerguy
     
  6. Matthew38

    Matthew38 Member

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    Wholeheartedly agree with the earlier comments, convert to 100% IO for the investment property so that you can maxmise the tax efficiency of the loan. Also from a tax perspective the ATO will only allow the interest to be tax deductible if the loan funds are used to invest in an income producing asset, i.e. an investment property. Many lenders and brokers have 100% IO loans available and you can discuss this with your current lender or log on to the web and looking at other options.
     
  7. vanessa

    vanessa V J Tait & Associates

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    Hi, its very confusing isn't it? I believe that all of what is said above is correct. The way I look at it there is good debt and bad debt.

    Good debt - is a debt you can claim tax advantages with eg investment
    Bad debt - is a debt you can't claim tax advantages with eg your principle place of residence.

    Idea is to have good debt and no bad debt, so by putting your funds into an offset account you can use that money to purchase your principle place of residence and reduce the debt you incur on that property.

    By the sounds of it you are in an enviable position and I would strongly recommend you obtain financial advice from your accountant or financial planner as what you do now and set up now may also assist you when you are wanting to purchase further investments.

    Good luck.
     
  8. ashnita

    ashnita New Member

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    I agree with the notion of good and bad debt.

    I also agree with Terry re the offset account.

    I would change it to p&i though to build up some equity in the property. When buying another investment property you can unlock this equity anyway and use it as part of your deposit. So you have not lost the power so to speak.

    Be prepared to listen to different opinions and make up your own mind.
    Good luck
     
  9. Jamie M

    Jamie M Mortgage Broker

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    TerryW above is on the money.

    It can be a confusing concept. I wrote the following article for Australian Property Investor on this topic - hopefully it makes sense and you find some value from it.

    ----------------

    We see it every day: people who pay down a large portion of the loan on their principal place of residence (PPOR) and now want to upgrade to a larger house while keeping their first property as an investment.

    So what's wrong with this? When their current property turns into an investment property (IP), the loan against it is generally quite small because they've paid down a considerable amount of the principal, which means they can only claim a small amount of interest. The good news is that there's a way around this - but it's important that it's set up correctly from the start! To illustrate how to get it right, let's look at the following examples:

    The not so ideal situation
    John purchased his first home in 2005: a one-bedroom apartment that he had a $300,000 principal and interest loan on. John was determined to pay off his loan fast and by 2011 it was down to $100,000.

    He now wants to buy a larger house and keep his apartment as an IP. Because John has paid his loan down to $100,000, when this property becomes an IP, he can only claim interest on a $100,000 loan, which isn't ideal since the property will achieve $500 per week rent.

    To make matters worse, John wanted to use the equity in his first property to purchase his next one. The issue is that the equity he's using from his apartment won't be tax deductible because it's being used to purchase a PPOR.

    So in this scenario, John has reduced his tax-deductible (IP) debt but has increased his non-deductible (PPOR) debt. Not ideal!

    The ideal situation
    If John set up the loan as interest only with an offset from the beginning, he wouldn't have this issue. Instead of paying down the principal, he could place his savings into the offset account which provides a similar outcome to paying down the principal. Instead of paying down his loan to $100,000, John would have $200,000 in his offset account and only be paying interest on the remaining $100,000.

    When his apartment becomes an IP, John can take the funds out of his offset account, which will boost the loan back up to $300,000, and use those funds towards his next PPOR. This way, John has increased his deductible debt (IP loan) back to its original level of $300,000 whilst reducing his non-deductible debt (PPOR loan) by $200,000.

    So make sure that you plan ahead! Not doing so could wind up costing you thousands.
     
  10. realestate_basket

    realestate_basket Member

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    That's very good responses from everyone.

    May I have a question?

    If I decide to refinance to another lender, can I apply for a bigger loan even though I nearly pay it off with the current lender? For example, atm I'm with a lender which does not have offset account but offers cheap rates. I have only less than $100K debt with them, when I am about to buy a new property to be my PPOR and to rent the current one as IP. I will move the loan to a new lender with an offset account. Will any lender accept to give me a $400K loan? and I will put the rest of $300K in the offset account which I will be use to buy the new house.

    Both my partner and I work full time so we shouldn't have problem in borrowing a big chunk of money, the main concern is whether they allow you to transfer from a small to a big loan.


    Has anyone done something similar before? Your thoughts and experience will be much appreciated.
     
  11. Billv

    Billv Getting there

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    No because you won't get a tax advantage.

    Once your loan is reduced, you can redraw on it and use the funds for investment or non investment purposes but if your new purchase is not producing an income you won't be allowed to deduct the interest on the redrawn amount
     
  12. realestate_basket

    realestate_basket Member

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    Thanks Bill for your reply. But you might misintepret my question.

    What I meant is to refinance to a lender for a loan on the same property (the one that I am currently living in) but ask for a bigger loan which will have an offset account (the loan that I am currently having has cheaper rates but not offset account). This is to be done before the purchase of a new home to take advantage of bad debt (as other people have said) in a way that I will have an interest-only $300K loan, and save all the cash in the offset account. When the time is right, I will use that cash to apply for another loan to buy a new home which will be PPOR, leaving the first loan to be the investment loan.
     
  13. Billv

    Billv Getting there

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    Yes I know where you are coming from but the fact that you'll have an offset which is like a savings account will not make the redrawn amount tax deductible. so you need to keep the remaining loan separate and the amount in the offset needs to be clean new borrowings
     
  14. Terryw

    Terryw Well-Known Member

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    i agree with Bill. you can do it that way but the interest on the increased borrowings wont be deductible.
     
  15. realestate_basket

    realestate_basket Member

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    Thanks Terry and Bill. I got what you meant now, but could you please explain why the extra borrowing won't be tax deductable even though it's still for the same house (the first one)? Sorry that I am not very knowledgable about this?

    I know you may ask me to refer to my accountant, but I don't have an account at the moment. If you can tell me which part of the tax rules discuss about this then I'll look it up.

    Many thanks,
     
  16. GregR

    GregR Reid Consultants

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    It is the purpose of the loan not what security is used, that is the critical factor in determining tax deductibility. If a loan is used to purchase an income producing asset, then the interest cost is tax deductible.

    If the purpose of the loan is to purchase (in full or part) a non income producing asset or fund private expenditure like an overseas trip or repay credit card debt or use to help fund the purchase of a owner occupied home, then it is not tax deductible.

    The tax act is not particularly helpful other than stating as below in Section 8.1 of the 1997 ITA:
    General deductions
    (1) You can deduct from your assessable income any loss or outgoing to the extent that:
    (a) it is incurred in gaining or producing your assessable income; or


    Be careful of many accountants, they simply do not know the law as it relates to property investment. I have come across a number who claim it is deductible and they are simply wrong.
    Good luck.
    Greg
     
  17. realestate_basket

    realestate_basket Member

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    Thanks very much for the info Greg!