Are we setting ourselves up to fail?

Hi everyone,

I recently posted in Where to Buy about our plans to buy a second property but thought I’d be more financial specific here too to see what your advice would be. Our current situation is:

- Married, late 20’s/early 30’s
- No dependents but looking to start our family next year
- Dual income of $140k pa
- Zillmere PPOR valued at $520,000
- Owe $405,000 on mortgage (3.75% variable)
- $33,000 in offset account
- Owe $9,000 on a 6 month interest free credit card
- Own our car, no other debt
- We currently each contribute a bit extra into our Super to lower our taxes each week (thoughts?)

- I’m such a rookie, can anyone explain tax deductibility on an IP? We pay roughly $30k in taxes a year, does this mean we could claim $30k in expanses on our IP each year?

- I’ve heard LMI on an IP can be tax deductible too?

Basically, we are currently looking at buying our second home (approx $600,000 in Stafford Heights or $700,000 in Wavell Heights) as our PPOR and turn Zillmere into an IP (rent approx $420 per week).

- We want a 3/4 bedroom, 1/2 bath on at least 600sqm, already renovated

We’re not necessarily in the game to make an absolute fortune, although of course it would be nice!
For us (be it right or wrong), it is more about lifestyle, comfortably raising our kids and ideally setting ourselves up for retirement.

Our main concern is that I will be off work on maternity leave for approx 12 months likely to start sometime next year, so our household income will drop to around $100-$110k during that period.

We kind of have our hearts set on moving into a bigger, nicer place in a nicer area to raise our kids (and know that if we don’t do it before having kids, we probably won’t do it for 10 years and by then will be priced out of the areas we want to live in) but we also don’t want to make a disastrous decision.

From what we know (which is very little), we should refinance Zillmere to LVR 95% (which would mean paying LMI again) and use all our available cash and equity as a deposit on the new PPOR?

Any and all advice would be great!
Thank you!

 

You're not setting up for failure.. you're doing ok.

A couple things I would do:
- Pay off that credit card and close it before applying for more finance. Or if you're going to take your time, pay it off completely just before the interest free period ends, then close it.
- Get financial advice on whether it's best to put extra into your super.. We earn double your incomes, and don't put extra into super.. it all goes towards non deductible debt.

LMI on an investment property can be tax deductible over 5 years. My understanding is that if you make your current property (whether it's still PPOR or converted to IP), you won't be able to claim the additional interest or LMI if you now refinance to 95%. Keep building up the offset, and transfer it to the new PPOR loan once you settle. Only the current $405k will be tax deductible once turned into IP.

We bought the big house in a nice area prior to investing or having kids - planning to grow into it rather than having to upgrade later. One of the best decisions we've made..

 

Lots of options and considerations. I'd suggest determining what your ultimate goal or priority is.

If it is to secure a new PPOR before the kids come, then look at how you will achieve that including exploring whether it is better to sell the former PPOR or convert it to an IP. You may wish to think about how you will reduce your new PPOR debt (non-deductible). Working this out may inform whether you direct funds to your super or to this goal.

Do you intend to pay out the 9k at the end of the 0% interest period? Is this a strategy you have adopted to keep the 9k in your offset and save some interest?

If you keep both. Can you afford to pay a 700k loan, plus the shortfall on the IP (it may not be CF+ve) on your incomes and chosen lifestyle? Will you be comfortable or stressed?

 

That’s good to know! Thank you!

We only recently increased our super contributions as my husband’s tax each week just seemed like a waste. We are speaking to a financial advisor on Wednesday so we’ll check that with him then.

Yes, we’re paying just above the minimum payment on the interest free credit card until the last interest free month (December) where we will pay in full.

That’s exactly what our idea is too. Buy the bigger, nicer place while we’re both on good full time incomes and grow into it with our family rather than having to upgrade once we have kids.

 

All very good points,

- we would really like to keep our current PPOR, we don’t want to sell, we know we would regret it.

- for the last 6-12 months, our aim has been to reduce all other debt (paid out our personal loans and other credit cards) and build up our offset account as much as we can.

- my employer contributes an extra 3.5% if I contribute 5% into my super so I’ve been doing that since March. Seems like a no brainer to me but maybe I’m wrong? My husband increased his super contributions to 12.5% because we figured it was better to be putting more money into his super than to waste it paying tax. Again, we’re talking to a financial adviser on Wednesday so we’ll see what they suggest re our super contributions. We can change that at any time.

- yes, the idea of the interest free credit card was to always pay it off before the interest free period is up. Although, until last month, we were paying $1500 a month off so we didn’t have such a large chunk at the end. We’ve now reduced our payment to the minimum $600 to keep cash in our offset.

- I’ve crunched the numbers and yes, we could afford both. The weekly shortfall on the IP would be around $100 (based on a conservative rental income estimate and a much higher IP interest rate). I’ve done the numbers if interest rates were to increase by 1.5% and we’d still be okay. Basically, we’ve been comfortably living on one wage the last 9 months or so and have reduced our debt to essentially nothing to see how we would fair when I’m on maternity leave and it seems we would afford a $700k property. I’m not saying we would be as comfortable as we are now of course but from what I can calculate, we would be okay

 

I would pay more money into offset and less into super.
Theory your paying 3.7% inter on borrowed money amd how much you making on the extra amount you pay on super.

My understanding was
Benifit of have a negitive geared ip is so if your out of pocket 20k a year thats 20 k less personal tax you pay. So instead of paying 30k a year you will get takes on about 10k

Well you will still pay tax for 30k through out the year but get a nice return when you do your tax return in august.

 

Yeah, fantastic. That’s my understanding also!

When we increased our super contributions, we weren’t planning on using our house as an IP but now that we are, I think it would make more sense to reduce our super and use the extra to put into our offset.

 

What I've realized ( my belief anyway) is to be 'comfortable' and 'set up for retirement' you need to be relatively wealthy. No 'cheap' option imo. Im sure many may disagree . That's fine . Just my observation over the years.

 

Looks like a similar situation to what my girlfriend and I were in 2 years ago.

Ask your financial planner about debt recycling it’s a great way to reduce your non deductible debt, improve your tax position & diversify your asset base.

In the meantime I’d be putting as much as you can save into your PPOR offset.

All the best with it!

 

Are you looking at a 20 + year investment or going to sell investment after 5+ years and upsizing. Mite slightly change how you look at things

 

A 20 year investment. By buying an upsized PPOR now, we won’t need to upsize in the future and we would hold onto the investment for the long haul too, 10-20 years, whatever we need to

 

No, it doesnt work that way.

You are taxed on your total income minus any deductions. Your deductions may include any costs to hold your investments.

For example

Wage $140k
Investment - income (rent $420pw) $21 840

Income total: $161 840

Deductions
(presume no work related deductions)
Interest:$15187
PM fees: $2000
Maintenance: $1500
Depreciation: $3000 (who knows the actual figure)
Insurance: $1500
Rates, water, land tax etc :$3000

Deduction total: 26187

Taxable income (total income from wages and investments minus deductions) = 135 653

In this example you pay tax on $135 653 ($40 432 tax per year) instead of $140000 ($42,127 tax per year). A saving on your tax of $1695 approx.

However, you have needed to pay the bills for the property upfront across the year. If you make a loss, this has come from your pocket each week.

Some people get all excited because they have paid a few thousand less in tax - yet the property has cost them triple that to hold. This might be great if the property is going up in value, however if it isnt, would you be better putting your money elsewhere.

If your rent goes up to say $600pw ($30k per year), your income would go up by that much. If your deductions stayed the same, you might have to pay more tax than you do now. But your property hasnt cost you anything to hold throughout the year.

Income
$140k + $30k = $170k
Deductions = 26 187
Taxable income = $143 813 ($43 614 tax payable)

 

On super, you should absolutely put in 5% to get the extra 3.5%. This is an absolute no brainer as you state. Think about it this way. For every $1 you put in, your employer puts in 70c. That is a tax-free / post-tax return of 70c (70%) in one year, and for the next 30 years, you will earn returns on the $1.70. This is obviously a phenomenal one-year return. To get a post-tax return of 70% at marginal tax rate of 40%, you would need to earn 116% (70% / .6). In terms of what that will grow to, even if you only earn 5% a year from hereon, that will compound to $7.34 over 30 years (again with the massive tax benefits of super when you take this out).

 

@LittleBlueHouse if you keep thinking like you are and keep asking questions I think it very, VERY unlikely that you'll be setting yourself up to fail.

Sounds like you're on the right track to me!

 

Thanks @hammer! Haha I agree

I know what you’re saying, I think we are very much on the right track. I just second guess myself sometimes so thought I should be as prepared as possible!

 

Thanks for the clarification! I thought my idea of it was too good to be true. This makes a lot more sense!