Newbie: First IP asking for advise on the loan

Hi everyone,

This is my first post here and hoping to get any advise from more experience investors on my situation.

Wife and myself is building a house in West side of Melbourne. Once constructed, this will be our PPOR and the current house that we live in will be converted to IP.

• Building a 4x2 house in West Melbourne total price is $600k (H&L). We will move into this new house once finished.
• The plan is to use our savings which is around $80k to $100k to fund for this new house
• I expect that the monthly repayments for this new house will be approx $2k to $2.5k
• Currently living in a 3x2 house in the same area (bought for $340k). We plan on renting this out hence will become an IP once the new house is done.
• Equity from our current PPOR is $140k approx but atm we're not planning to use this equity
• Remaining loan for our current PPOR is $240k with repayments of $1.2k per month
• When we transfer to the new house and have the old house rented out, we expect to get $1.4k per month rental income (conservative). Hence, expecting to have a marginal net income of $200 per month ($1.4k less $1.2k)
• Household income is around $$230k

As a newbie, I'm a bit confuse on the best option to take that will end us saving more money.

Question - are we better off using our savings (i.e. not use our equity) to buy the new house? At the same time we will get a monthly net income from rent of $200 (as per above). In this example we will end up having a higher loan in our new house of $500k compare to loan in current house of $240k - Option 1; or

Is it better to use the current equity we have to fund for the new house and so our total deposit will be $240k comprise of $100k (savings) plus $140k equity. This will end us having a lower loan in our new house of $360k ($600k less $240k) but our loan for the old house will increase to $380k which is the sum of $240k current loan plus $140k equity to be pulled. A friend told me that this maybe a better option since having a higher loan from IP means a higher interest expense claimable under tax. Also this will end us being negatively geared. - Option 2

Any advise will be much appreciated!

 

If the value of the property you're building is $600k, your savings of $100k isn't going to be enough to cover a 20% deposit needed to avoid mortgage insurance. You've got some equity in your existing property, so it makes sense to access the equity and avoid the LMI cost.

In essence, you need to borrow about $510k in total. If you borrow all of this against the new house you're probably going to pay about $5k in LMI. Or you can borrow $480k against the new property and $30k against your equity and avoid LMI completely.

Your friend is wrong in their assumption that borrowing more against your current home will increase tax deductions. Only the money used to purchase that property will become tax deductible when it becomes an IP. Any money borrowed above the original $380k will be tax deductible if it's used for investment purposes which providing deposit on your new home is not. Option 2 does not exist the way you think it will.

 

Think you should focus on saving money from your salary and growing your investments, not focus on saving money on your investments.

 

Thanks for the detailed response Peter. Much appreciated!

Yea that also what we're thinking about accessing the equity to avoid LMI.

I've always had this not so good impression about accessing the equity in a property given that ultimately it is still a liability that you have to pay to the bank as oppose to actual gain that will go to your pocket.

Additional question - is my understanding correct that the loan in our old house even if it becomes IP in the future, the monthly repayments and interest won't be tax deductible given that the original purpose of it was PPOR? Or once it change to IP next year, we can claim it as tax deduction?

 

Thanks!

 

Hi Rolf - Do you mean whether we withdrew equity in the past on the loan from old house? We have not...

 

Once it changes to an IP next year, you can claim the balance owing as a tax deduction, yes

 

It's actually suprising how many people don't realised what you've indicated. Using equity is an act of borrowing. Many seem to think it's free money.

Given your savings are limited, you're going to have to borrow the same amount regardless. If you borrow some against your equity you can avoid the additional LMI cost on top of that, plus you'll likley get cheaper rates.

In this case the best argument for borrowing more than 80% would be if you're intending to preserve some capital for something else. LMI can be a legit cost of preserving money for future projects.

 

While this is true, I prefer to use the Bank's money while it's relatively cheap and allows me to keep my cash aside for other opportunities as they come up.
Each to their own

No, I suggest getting a decent accountant/tax adviser on board to assist you with your tax advice

 

it’s not the purpose of the loan that determines deductibility but the use. If the loan was solely used to buy a property and no redraws then the use relates to this house. If this house later becomes income producing the interest relates to this income and would be deductible.
I have written a tax tip on this here. If you want a link let me know and I will post it later

 

Depends on what you use the equity (which as others have said is simply borrowing more money) for. If you use it to buy something that goes up, then that's gain you wouldn't have had otherwise.

 

Oh this concept of redraw was new to me - thought it was equity. I just googled it and its basically the excess amount paid against the scheduled loan repayments. So thanks for bringing this up.

For us, we just pay what the scheduled repayments are so not applicable.

 

Thanks Stoffo.

 

That also make sense.

 

Thanks for the response Terry. This made it more clearer.

Yes please would be good if you can also re-share the link

 

if you have an offset account attached you could still be ahead even though you pay minimum