Loan Tip: Using a Term Deposit as Security for a Home Loan?

It is possible to use cash as security for a loan. This may sound crazy – you would need to put an amount equivalent to the loan into a term deposit in a bank which has the mortgage over the property to secure the loan. You would get a very low interest rate on the deposit but still be paying a higher interest rate on the loan so you would be going backwards. Why do it them if you could just use the cash to pay out the loan instead? Tax reasons!


Example

Homer has sold his main residence for $1mil. He had 2 loans secured against this property:

Loan A for $400,000 which was the loan used to buy this place originally

Loan B for $200,000 which was used as a deposit on an investment property.



Homer’s sale of the main residence could only settle if the mortgage against it was discharged. To discharge the mortgage all loans secured against it would have to be paid out or moved to be secured by something else.

If Homer paid out Loan B he would be paying $200,000 off an investment property debt – for a property that he is keeping. At 3% interest that would mean $6,000 per year in lost tax deductions for the next 20 to 30 years potentially.

Since he plans to buy a new main residence very soon, if he did pay out the Loan B above, he would have $200,000 less cash available for the purchase of his new main residence.



Therefore, Homer needs to change the security for Loan B to enable this loan to remain open. Ideally the investment property would be the place the secure it, but in this instance it has not gone up in value and the LVR is already 80% so this cannot be done.



The solution is to sell the main residence, pay out Loan A and keep $200,000 in a term deposit with this as security for the loan. Homer sold the house for $1mil, so after paying out Loan A of $400,000 he has $600,000 left. He puts $200,000 into a term deposit and has $400,000 in his pocket.

A short while later Homer finds the new main residence and goes back to the same lender asking for a loan to buy it.

They will lend Homer up to $800,000

He will split the loan as follows

Loan A, $600,000

Loan B, $200,000

The bank will then swap the security for the $200,000 loan to the new main residence. This will be inserted as Loan B above.

$200,000 cash will be released as well Homer will have $400,000 from the sale so he has $600,000 to cover the 20% deposit, the stamp duty and any left over will be placed into an offset account attached to Loan A, the non-deductible portion.

The interest on Loan B will remain deductible as that loan was used to pay the deposit on the investment property and can be traced back to the previous loan.

After discharging the mortgage on the property sold, the term deposit was paying Homer 0.5% pa in interest while the interest on the loan was 3% p.a. so Homer was actually losing money at the rate of 2.5% x $200,0000 = $500 per year.

But going forward he will recoup this in the first year with the ongoing tax savings.

 

Hi Terry

I have a few questions about this,

1) do some banks do this better than others? Any main players?

2) reference your example - instead of having loan B as a single 200k split for the investment property purchase, there were 2x 100k splits for the investment property. - could these loans be merged into to the one at the same time? Assuming there weren't any mixing issues

3) one the security has been switched for cash in a term deposit, would there generally be a timeline it could remain as such before the purchase of a new property? Would a couple of years be too long?

 

Some lenders are not ADIs (ie they cant offer savings accounts) so these lenders cant usually assist eg Pepper. Consider broker support to address who can and duration. Cant imagine it can be easily open ended where a short term is often more acceptable.
Also consider rate differential as a cost of doing this. eg borrowing at 5% and TD at 2.6%

 

1. Yes major banks would be best at it
2. Yes but it might be better to split so that break fees potentially less if you want to partially get out
3. I am not sure but generally this would be for a period of 6 months or so. It could be longer though but it costs you with the interest difference