Loan Tip: Tax Issues and Offsets, Redraw and LOC Loan Products

Discussion in 'Loans & Mortgage Brokers' started by Terry_w, 16th Jan, 2020.

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  1. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney

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    It is rare for a broker or banker to be trained in the tax issues surrounding the different products and features that are available, so they will often say incorrect comments such as ‘using redraw is the same as using an offset account’ – there are significant tax differences between the 2. Using a LOC as the main loan also has some significant tax issues.


    Here is a summary of when to use what:


    Offset Accounts

    An offset account is just a savings account linked to a home loan. The money in the offset is used to notionally reduce the loan balance without the money actually being paid into the loan and it will save you the same amount of interest as if you had paid into the loan.

    Ideally you should have at least 1 offset, in most cases you should not have a second offset. The offset account should be the place that all savings, rent, wages, inheritances and other money belongs.

    The main offset should be linked to the non-deductible loan against the main residence. If you don’t have a non-deductible loan the next best loan to link an offset to would be to the investment loan with the highest interest rate – assuming one owner of all properties.

    You might need a second offset if the first offset is full.

    Don’t borrow money and place it in an offset account.

    Tax Tip 1: Parking borrowed money in an offset account Tax Tip 1: Parking borrowed money in an offset account


    Redraw Facilities

    A redraw feature is a facility feature of a home loan whereby if you have made extra repayments into the loan you could pull those extra repayments out again.

    In most cases it would be great to have a redraw feature available on a non-deductible main residence loan. This is because you could pay down the loan then redraw, which is reborrowing, and invest and have the interest on the loan being deductible.

    Generally, a redraw feature is not needed on an investment loan as you would not want to pay extra off an investment loan – you could just use an offset instead.

    One reason you could want an investment loan with redraw is if there are different entities owning property and you want to cause one entity to reduce its debt and another entity to increase its debt. An example of this is 2 spouses owning separate investment properties with the main residence paid off. The spouse on the lower income may pay down their loan and then redraw and lend it to the spouse on the higher income to invest.


    LOCs

    A Line of Credit or LOC is like a big credit card. These loans allow deposits to be made and money to be redrawn and bills paid directly from the loan account. These features make it both a terrible product to use yet also a great product.

    They are terrible to use as the main loan because with the frequent deposits and withdrawals the loan will be rapidly a mixed purpose loan and if the property which the original loan used was rented out there may be a high balance but little to none of the interest would be deductible because the loan relating to the original purchase of the property was constantly reduced with each deposit. Also, if the LOC is paid down and used to invest in a new property if you made any further deposit you would be reducing the tax benefits. An offset cannot be linked to a LOC either.

    Other disadvantages

    a) Higher rates generally
    b) Often are at call – not a 30 year term like normal loans
    c) No ability to link an offset account

    However, the benefit of the LOC that it can be used to pay bills directly is the most important feature. This means if an investor wants to pay the rates on an investment property with borrowed money, they can just pay directly from the LOC itself with no need to worry about money taking detours or risking contaminating the loan like happened in the Domjan case. Most people doing this may tap into equity using a second loan split and then park this money into an offset account and then later use it from the offset account. This has significant disadvantages and risk as outlined in

    Tax Tip 20: Never use a LOC as the main loan
    Tax Tip 20: Never use a LOC as the main loan!

    But some term loans also allow for payments to be made directly from the loan account.

    Summary of when to use what loan product

    a) Offset account to hold cash until you are going to use it;

    b) Redraw only to be used if going to invest but the loan should be split first, then money from the offset used to pay down the new split and then reborrowed to invest – but watch out for the issues discussed in tax tip 1;

    c) LOC should be used to access equity as it avoids the tax tip 1 issues completely. But once used it should be converted into a 30 year loan at a lower interest rate – generally.
     
    craigc, jembuss, Simon Moore and 2 others like this.
  2. Harry30

    Harry30 Well-Known Member

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    Hi Terry, terrific loan tips. Very helpful. Got me thinking - it would be great if there was a proper list of them with appropriate numbering similar to what you have done with your tax and legal tips. Perhaps I should start a separate thread?
     
    Terry_w likes this.
  3. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney

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    Yes feel free to. I can update that thread with new tips, thanks