Margin Loans Margin loan v Equity loan

My position is as follows:

Married no kids both in mid 30s

joint income 109k

IP loan 280K (unit in Brisbane)

PPOR value 520K
PPOR loan 245K
Offset 246K

When I first started working I invested into MFs this as you can see has helped with the the purchase of my PPOR. Now while the market is depressed I feel its a good time to reenter the market.

So I was thinking of getting another loan to purchase shares. Looking for tax effective income. What are the pros and cons of equity loans & margin lending. I understand that with a equity loan you are putting up your house as collateral and with a margin loan you need a share package to offer as collateral. With times like these with the market declining you could get a margin call on a margin loan and have to find the money or sell off at a loss to cover the call. With a equity loan you just have to ride it out and make sure you can cover the interest bill of your purchases.

Guess I am sitting on the fence with both types of loans.

Time to get my money working for me......

 

I think there are two major points - the first is the lack of a margin call with an equity loan - which you've also covered.

Secondly the interest rate on the equity loan should be much lower than a margin loan - at least 1%.

 

You could easily set up a line of credit against your PPOR, you can do this without even thinking about your first share/MF purchase.

Given that it may take a couple of weeks to get this sorted with your bank, it's smart to get started soon... it's fast approaching bargain time!

But be very vigilant with your LOC, it must be exclusively for income-producing investments, not holidays! But you've proven your diligence already with your fantastic offset record.

Remember that the LOC should cost you zero to set up, and you don't pay a cent for it until you start investing.

A ML will be simpler to setup (they're very keen to have you on board), but as samaka said, there are two very obvious down points vs a LOC.

 

Have you considered just ripping out some of the cash in the offset? It's pretty much the same thing, without the paperwork. It will also be at your current home loan rate, which is normally slightly cheaper than the LOC rate.

BR

 

But not deductible!

 

Hi Rod,

Isn't it about the purpose in which the money is used?

Cheers,

Dan

 

Yes it is the purpose of the loan that counts, that why Rod_wa is correct.

Using funds from an offset account linked to a non deductable loan does not change the purpose of the orginal PPOR loan to investment. The investment was funded from a offset savings account so directly no deductable interest involved. The increased interest on the PPOR isn't deductable. Now if the offset was linked to an investment loan the story is different.

 

A lot of people including myself, use both together for investments.

 

With big market falls like we are having now a margin loan doesnt appeal to me. Thou I can see the gains from having one. By having a foot in each camp I guess you could move your risk around.

 

If you keep a moderate LVR say 50% against a portfolio which allows a max LVR of 70 ~ 75% you would be able to sustain current drops without a margin call.

 

A 50% LVR followed by a 30% fall leaves you with 71% LVR.

A 50% LVR followed by a 40% fall leaves you with 83% LVR.

So taking a margin loan at 50% LVR now, with the market down more than 20%, could be considered 'sleep at night' stuff.

I just reckon your buying should be selective (eg fully franked dividend paying ASX20 shares that have been unfairly beaten up).

 

Why not consider instalment warrants vs Margin Loan. No Margin Call !!!! I am slowly coming up to speed on the concept and cannot say too much other than 'take a look'.

 

Why not just use Offset savings to completely pay down PPOR loan to zero, then get bank to switch it to an investment loan or credit line. (Make sure bank does not close loan account once balance reaches zero, sometimes a nominal amount needs to be left to keep account open eg. 50 cents to $1. Also need to check there are no penalties if paying down such a large amount.)

This way future drawdowns would be deductible if used for investment (except for the interest on 50c to $1 balance of PPOR debt). Other option is to take out a second investment loan with the same lender against PPOR.

I think you could also just pay down eg 40k off PPOR, then redraw it and use it for investment. Once you can prove the funds were redrawn for purpose of investment, surely the interest on that portion of loan would be tax deductible. ? ? ? This is a last resort though, as it is messy calculating portion of deductible interest, especially when it can vary each month due to the offset balance. But it can be done, it just takes a lot of maths at tax time. Also, if you want to draw down further amounts later on, the maths gets even more complex.

It is much easier to keep private and investment loans separate from each other. There is no reason you could not have a private PPOR loan and one or more investment loans, all secured against your PPOR.



Cheers
Seaview

 

Just to clarify my point about the LOC vs the offset.

The interest paid on an LOC, which is purely for income-deriving investment purposes, is fully deductible.

Taking cash out of an offset account to buy investments? No tax deductions - it is exactly the same as buying the investments with cash; you can't claim a deduction for the interest you might have paid if you had bought the shares with a loan. Pay no interest, get no deduction.

Using your PPOR loan to buy investments is very awkward. Not only do you have to determine the interest that is attributable to the investment only, the bigger issue is that as you make payments to the loan, these must be apportioned across both non-deductible and deductible components. Thus you cannot pay off your non-deductible debt first. This is very inefficient, as the tax deduction will decay as the loan is paid off. Note that even a so-called split loan does not solve this problem (the ATO has already ruled on this).

The clear solution is separate loans for PPOR and investments. This has the following benefits:

(i) The interest on an investment loan (LOC or ML) is fully deductible (provided the investments are income-producing now or in the foreseeable future).

(ii) Tax-time paperwork is simple.

(iii) Clear distinction - for you and the ATO - between borrowings.

(iv) You can pay off the PPOR (and other non-deductible loans) before the investment loans; even quicker by directing investment income towards the PPOR loan (offset account).

(v) The PPOR loan can be principal & interest for peace of mind (or bank demand), whilst any investment loan should be interest only (at least until the PPOR is paid off). Better still though, is to keep all loans IO; the PPOR can be effectively paid off by placing all cash into an attached offset account.

(vi) The IO investment loan may have interest capitalised.

Hope this clarifies some things.

 

I think you have missed the increased PPOR interest exposure that can occur.

Suppose you have a $100k PPOR mortgage with an associated offset account that has a $20k balance in it. At the moment you are paying non-deductible interest on $80k. If you take $10k out of the offset account to buy shares then you are now exposing $90k of your PPOR to non-deductible interest charges. Thus, while you are not paying interest on the money you used to actually buy the shares, you have to pay non-deductible interest on the previously `protected' part of your PPOR. Not good.

If you wish/have to use money in a PPOR offset account to buy further investments of any description then it will probably pay you to to `debt recycle' it first.

Basically, from an investing point of view, the only benefit for having an offset account against your PPOR is if you intend to turn it into an IP at a later date. It gives you an effective way of `stashing' your hard earned money until you purchase your new PPOR.

Tailcat

 

Agreed 100%. I was just making the point that the offset is not deductible.

 

Once you have a few IP's, at what stage do you start paying down the principle on them? Usually investors want to use interest only, so that they are paying down the principle later. At what stage though?

 

Each to their own. It depends on circumstances.

Assuming that there is no external influence, like massive interest rates, to force your hand, there is no point reducing any IP mortgage until you have bought ALL of your IPs (and shares/funds). This is obvious if you think about it for a moment; why use money to pay down one loan, when it can be used to support a new loan for the next investment.

Obviously, paying down the `bad' debt of your PPOR is a different thing.


Tailcat

 

Remember that the main purposes of an IO investment loan are
- to maintain maximum deductibility
- to minimise payments (which maximises available cash).

When do you start paying them off? Entirely up to the investor. But obviously only after you've paid off all non-deductible debt, and then when you choose to bring down your principal and LVR, and maybe only after you choose to start downsizing your PPOR.

I don't see any merit in being debt free until well into retirement.