Loan Tip: Structuring the Renovation of a PPOR

Discussion in 'Loans & Mortgage Brokers' started by Terry_w, 13th May, 2016.

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  1. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

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    Structuring the Renovation of a PPOR

    Not sure whether this post should be in finance or tax. It mainly relates to loans with a bit of tax advice so I put it here.

    When renovating a PPOR and paying for items and services most people don’t consider tax issues at all. Expenses associated with the main residence are private expenses and therefore there will be no deduction available - immediately.


    But tax should be considered because there may be a chance that the PPOR will be rented out.


    What if you have cash in an offset account and a PPOR loan with redraw available.


    Example

    Elon has a house worth $500,000 and a loan on this for $200,000. He has an offset account holding $200,000 so pays no interest on the loan at all. He wants to spend $100,000 to renovate the house. He has 2 choices:

    1. Use the cash in the offset account, or
    2. Borrow

    Elon thinks “what the hell would I borrow money when I can pay cash?” But realised that either way, the overall interest bill will be the same.

    · If he goes with 1 then he will start paying interest on $100,000

    · If he goes with 2 then his loan will increase to $300,000 but $200,000 is offset so he will only be paying interest on $100,000


    The difference

    The difference will be felt when the house is rented out in a year’s time when Elon upgrades to a new PPOR.

    With option 1 he will only be able to claim the interest on $200,000. He will take his offset money with him to offset the new PPOR loan

    With option 2 he will have an additional $100,000 which he can claim the interest on. $200,000 of the original loan and $100,000 of the new loan will be deductible because the funds of both were used for the acquisition and improvement of the property and it is income producing. Therefore, Elon will be able to claim interest on $300,000. An extra $5,000 in tax deductions for the next 30 years (at 5% pa interest) will help him pay off the new non-deductible loan much sooner.


    Structuring the Loan

    Elon can do this 2 ways:

    1. Use redraw on the existing loan, or
    2. Use a separate split

    With option 1 there will be no mixing because the original loan and the redrawn amount will be both for the same property.

    All loans should ideally be IO.


    Elon should take the usual care than the extra money borrowed is not contaminated by withdrawing and parking with other cash etc. Paying directly from the loan account is the way to go.


    Elon should also be careful that no other expenses not related to the house are ever borrowed together
     
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  2. Elives

    Elives Well-Known Member

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    Hi Terry,

    if i have an ip with 40k equity and 40k cash in offset Knowing and about to buy a ppor with the idea of only living in it for 1-2 years and then moving overseas. should i use the equity? because in the 1-2 years i wont be able to claim the 40k interest repayment deductions as it's ppor but afterwards while it's rented would benefit more in the long term?

    Cheers, Elives
     
  3. wobbycarly

    wobbycarly Well-Known Member

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    Elon? Can we have a surname with this example please?
     
  4. Chris Au

    Chris Au Well-Known Member

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    Thanks for your wisdom and clear explanations @Terry_w . This applies mainly if you are looking to rent out the PPoR in the future?
     
  5. albanga

    albanga Well-Known Member

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    I think the point is it doesn't matter.
    You may never have intentions of renting it out but why not plan for it anyway?
    Financially their is zero difference. potentially their is a huge financial difference.
     
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  6. gman65

    gman65 Well-Known Member

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    Very valid tip! I imagine quite important for a lot on PC
     
  7. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

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    I think you are asking if you should borrow to buy a main residence - a temporary one.

    Yes why not? If you keep the $40k in the offset account you won't have incurred any more interest, but you will be larger deductions when the property is rented - if you use some or all of that $40k.

    If by borrowing the extra $40k you will incur LMI then that may change things.

    Also consider your plans may change and you may not end up living in the property.
     
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  8. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

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    If you never rent the place out there will be no difference. But plans change and borrowing now can cost you the same in interest, but gives you more deductions later - its more flexible/
     
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  9. Tuff Gong

    Tuff Gong Active Member

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    Awesome post @Terry_w as usual!
    So in my case, I have a PPOR with funds sitting (say 200k) in the offset which will be used for renovation (say renovation cost estimate is 50k). The PPOR may become an IP in the future but there are no plans to do so anytime soon.
    PPOR loan balance is 900k with AMP Master Limit.
    1) Does it work if I reduce the main loan balance to 850k and create a new split of 50k?
    2) Do I then transfer 50k from the offset to the newly created split?
    3) I will then have a balance of 0 on the split with 50k available in redraw which can be used for the renovation. Is this correct?
    4) As the renovation will be done in stages, say 3 payments (10k, 20k, 20k), can I redraw the 3 amounts? No issues with that? I don't need a separate split for each?
    5) What if the renovation comes under budget, say by 5k. Do I just leave the 5k in the redraw or can this go back to the offset?

    Or do I use equity to fund the renovation? This may require a valuation to determine how much equity is available as I don't know how much is available right now.
    Can a bank do a revaluation free of charge?
    Would equity release require a new application?
     
    Last edited: 10th Nov, 2021
  10. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

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    Not sure what you are thinking here, but I can't really see a point in paying down a loan for property A and then immediately increase the loan by the same amount and use it for property A.

    My tip was about borrowing to do renovations and keeping your cash to debt recycle later.
     
  11. Tuff Gong

    Tuff Gong Active Member

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    I thought by creating that split for the renovation (and therefore keep it completely separate to keep it easy for accounting purposes) and redrawing the 50k that if the property becomes an investment later on I would be able to claim the interest on the 50k. Is that not the case?
    Maybe I misunderstood but I thought this was in line with your example.

    Or are you saying that I don't need to do the split, I could just pay the 50k into the main loan and redraw? And claim interest on 50k once it becomes an IP?
     
    Last edited: 11th Nov, 2021
  12. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

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    Thats the case but the paying down of the loan by $50k first cancels this out.

    It would be better to just borrow $50k on top of existing loans and keep the balances high.
     
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  13. 1-Brissy

    1-Brissy Member

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    Hi Terry,

    I have been thinking to do that way for my GF and wondering if refinance is the only option for borrowing on top of the existing loan?
    As I just fixed my 600k mortgage at 1.79%, and of course I don't want to break it and refinance with higher interest.

    Hope to get some insights

    Cheers
     
  14. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

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  15. 1-Brissy

    1-Brissy Member

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    Thanks Terry

    We are planning to get out GF done during April/May and hopefully get rented out by that time. We then will convert this 600k mortgage to IP. Should those 2 loans still be kept seperated and what if we would like to refinance the property

    Cheers
     
  16. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

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    You don't convert a mortgage to IP, you would be renting out the main residence and the loan would relate to this and be an 'investment loan'.

    I would keep the 2 loans separate in case you ever move back in to either the main house or the GF
     
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  17. 1-Brissy

    1-Brissy Member

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    Thanks Terry for the feedback
    I will contact my lender to inquire top up option

    Appreciated

    Cheers,
     
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