Borrowing to pay capital / No interest impact

Hi All,

I'm thinking about strategy for managing the transition from Interest only to Principle and interest on several property loans.
Given my portfolio is cashflow positive while IO, managing interest payments is no issue so my question relates to paying the principle component.
My thoughts are I could redraw the loan into an offset account to the tune of the capital component required each year.
Therefore I wouldnt be borrowing to pay interest, and the interest charged would not change because its offset. I would be borrowing to pay capital. Is their an issue with this in the tax departments eyes?

What do you guys think?

MJK

 

There could be some fairly nasty tax implications of doing this, best to seek specific advice on that aspect.

A couple of things to note:
* You will pay more interest. As you draw money from the offset account, the interest on the loan it offsets will increase.
* You're borrowing to pay down debt. What happens when the money in the offset account runs out? I've seen people do this strategy prior to the GFC, it doesn't end well.
* If you're going to have trouble affording the loan with P&I repayments, you almost certainly can't afford to borrow more to meet those repayments.

Sooner or later your loans will become P&I. It's inevitable. This isn't a bad thing.

 

I think it has legs. Get some tax advice

Tax Tip 46: Want to Pay IO on a PI loan? Tax Tip 46: Want to Pay IO on a PI loan?

 

Hi Peter,

Thanks for your reply. It is helpful. I would offer the following to the debate.

1. I wont pay more interest because the redrawn loan is offset by the redraw. So as the money flows from the offset back into the loan the interest charged is effectively lower again. Its contantly offsetting so the interest PA never changes.
2. I wouldnt be paying any debt down as each year the loan would be raised by the redraw and reduced by the capital payments to equal degree.
3. I will have no trouble affording P & I but it doesnt suit my strategy. I personally believe its a failing to pay off deductable loans as I would rather offset them I have some loans that are totally offset to the point that there is no interest charge at all but the finance is available to me at a whim.

I do appreciate the sanity check but I would never allow my debts to increase without acquiring more equity and cash flow.

MJK

 

Isnt this a zero sum game ?

You pay down the loan and that creates available redraw. You draw that to an offset. If you leave the $$ in the offset then the loan balance rises as does the offset 1:1 but the net balance subject to interest is unchanged. I see no concern and it does leave you with parachute money until lender requires the loan go P&I. IO wont last forever. And the term may reduce significantly at that term meaning a large reduction is required to avoid major increased repayments. Nil effect. BUT...

The concern would be using the offset. You would have a blended loan. eg New $$ drawn repay proportionately against loan being paid (eg PPOR loan) Or may have a capitalised loan issue between one property and another. If a loan is P&I you cannot elect to treat one part of repayment as the capital and another part as the interest. A binding private ruling would be sensible to avoid the ATO denying all or some of the interest deduction well in the future if they dont agree on the basis of the funds used for a deductible purpose.

Part IVA could apply if a benefit arises in the systemic use of the facility and its planned implementation - Has elements of a scheme. Question is whether it produces a tax benefit. That could be a gimme to the ATO allowing them to cancel the apparent benefit in whole or part as they see fit. Costly to object.

 

Hi Terry,

You and I are on the same wavelength. Thanks for the link to Tip 46. I will give this some consideration. I also wonder, as one approaches semi retirement and income drops into the lower brackets and is subsidised by equity rather than income, and as eligibility to access super approaches....whether tax deduct-ability is even that important. One could perhaps redraw a loan to pay another without requiring a tax deduction.
I have to do some calcs on this but it could bridge the gap between early semi retirement and reaching an age where Super becomes the main source.

The banks concern about IO loans is justifiable but they just dont trust the fiscally controlled amoungst us to manage our own affairs based on our own timing. Life wasn't meant to be easy!

Regards

 

@MJK I misread one detail that you're going to redraw money in the loan. I misinterpreted this as you'll set up a second loan with an offset account and use the equity release to make payment (I guess the title 'Borrowing to pay capital' influenced my thinking).

On this I think Paul is right. It's a bit of a zero sum game, but it does open you to mismanagement and possible contamination of the deductibility of the loan.

 

Thanks Paul,

Yes its a zero sum game. Absolutely correct.
In my case there is no PPOR to worry about as its paid off. All debt is for investment purposes.
The differentiation between capital and interest not being able to be defined is most certainly a consideration.
There is zero tax benefit being derived. Its simlpy trying to not pay capital.

I may have to burn my cash in the offsets over the next few years whilst redrawing to pay rates,insurance, agents fees and maintenance in every instance to limit paying the loans to faster than desired.

Regards,

 

if you have paid off the main residence wouldn't it not matter so much if you ended up paying PI on investment loans? I guess you are trying to preserve your cash for an earlier retirement.

 

Thats correct. Live off equity or cash in offsets, which is virtually the same, until super is available and I'm ready to sell a property to finish debt off. I want the cash and so does the banks.

If I use cash in offsets to live then the un-offset portion of the loans that attracts interest remains tax deductable. If I pay the capital down in a PI scenario I loose the access to the equity without creating non deductable debt and split purpose loans etc...

 

Its not really the same as there are different tax consequences.

If your serviceability is good I would be looking at setting up a facility to borrow to pay for investment expenses, and possibly even interest. No non-deductible debt may mean there is no immediate tax advantage, but it will pay off once you enter the non-working stage.

 

I may look at converting a standard loan with a current LVR of 20% into an LOC /Equity Manager loan. That may cost me 1% pa extra in interest but should give me a level of comfort. Id pay the balance off from offset cash to start from scratch.
I think I will redraw my property expenses excluding interest and principle from my standard property loans to offset capital payments.
The new LOC will avoid is original loan from going P & I and retain available buffer.
Another couple if IO loans wont expire for some time so we'll see how it goes. One in 2020 and the other in 2024.
I can run the LOC as a non deductable source with a minimum balance but still retain flexibility. I needed to stop this loan from being recalculated to P & I based on original balance rather than current balance.

I hope that makes sense? Lets see if they will convert my loan to LOC?