Tax Tip 2: Debt Recycling

Hey guys, crunching numbers and using current NAB rates as an example, PI Variable on 3.79% and IO Variable 5.08%. In the case of recycling PPOR debt into Shares I don't see the big win for using IO splits over PI splits ref Tax Tip 13. But very interested in some insight and maybe proven wrong here.
I can see the use of investment loan on IO for the IP as a way of affording to 'stay in the game' and with the deductible interest upside as an assist.
However, in the case of a loan secured by the PPOR and with the PPOR competitive rates over 5 years at 37c tax bracket this looks like:
IO Splits: I spend $22.01 and I get $8.14 back with no increase in equity. Cost to wealth is $13.87 for the pleasure of a $100 investment in shares over 5 years.
PI Splits: I spend $27.92 and I get $6.68 back with $9.86 increase in equity. Cost to wealth is $11.38 for the pleasure of a $100 investment in shares over 5 years.

Where have I gone wrong? Considering this strategy is to use equity in the home to reduce non-deductible debt, PI Splits are faster?

 

NAB are not the best bank for debt recycling, but at those rates you would be better off at PI, as the repayments for a PI loan would be about the same as the IO loan, but you are also reducing principal.

 

Thanks for the replies, so these are abnormal rate spreads. I'm keen on getting more sophisticated with the PPOR equity particularly as interest rates are so low but can't bring myself to pull the trigger on IO!

 

Take care rate spreads arent what they seem. Banks are making more $$$ that ever before with maintained spreads. Its the lie they want all borrowers to believe.

A 50pts spread at 7% is nothing like a 50pts spread at 3.8%. The 50 pts spread at 3.5% is worth 53% more to the lender.

 

My concern exactly, now that PPOR loans are so low it's hard to look at anything above 4%.

Edit: That's low rates of P&I loans I'm referring to

 

Hey @Terry_w, tax question for you.

Let's say I split my PPOR loan into two. Loan A $490K, Loan B $10K. I pay down Loan B, immediately redraw and invest in income producing shares that pay a 4% fully franked dividend (5.7% grossed up). My PPOR interest is 3.6% and my marginal tax rate is 37%. This means my after tax return is 3.6%. So in other words I have made zero return against my investment (interest paid is equal to return). What does this mean for claiming interest on Loan B? My claim is 0 right?

 

Good question skinner. Is there a simple calculator out there that does this calculation for you? Something that tells you if the payoff is worth it.

 

No.

You would have had income from the shares which the interest is claimed against. You shares are making a 'profit' and you would pay 37% tax on this profit.

Work it out with actual numbers, rather than %, and you will understand.

 

OK so with real numbers:

$10K invested.
$400 dividend
$171 franking credit
$571 taxable income
Tax rate - 37%
Gross tax payable - $211
Tax payable (less franking credit) - $40
After tax return - $360

$10K loan
3.6% interest
$360 interest

Net profit - $0

At what point is the investment loan interest claimed?

 

$571 income
$360 expenses
----
$211 net income.

this is added to your other income for the year and you should get a franking credit
You might be ahead by $211-$171
plus any capital growth.

 

Got it now. Thanks Terry. The return is small but over time it will add up I guess.

 

Don't forget there are 2 aspects to debt recycling
The 2 broad methods of Debt Recycling The 2 broad methods of Debt Recycling

 

I am unable to find @Terry_w tip that shows paying 800K on PPOR and the borrow it to reinvest (it also has reference of $1)-anyone can direct me the link/thread

 

It might be one of these:

Strategy: Don’t Keep Large Sums in Offset Accounts Strategy: Don’t Keep Large Sums in Offset Accounts


Strategy: Borrow Against the Main Residence for an Investment Loan (Shuffling Loans Around) Strategy: Borrow Against the Main Residence for an Investment Loan

 

Bundle of thanks-I am still learning and yet to see the bigger picture.

 

Hi Terry,

i have NAB ppor loan, and i have cash in offset. i'm self employed. i spoke to nab and they said you can't pay bills straight from the home loan account but could set up a seperate transaction account so money would come out of the loan into trans account and then from there pay the bill.

1. will the interest still be deductible doing it this way etc paying the expenses from the trans account?

2. can i set up in NAB 2-3 trans accounts for IP's and one for business expenses? would this be a good way of doing it?

3. can you make loan repayments for IP's from your redraw or is that illegal?

4. can i pay income taxes / gst from redraw?

Cheers, Elives

 

Hi Elives

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

2. potentially see above

3. not illegal but you would be borrowing to pay interest, see

Tax Tip 16: Capitalising Interest Tax Tip 16: Capitalising Interest

 

i think i added dot point "4." before you replied on original question is that one illegal?

for 1. & 2. just wanted to clarify i read the thread and am i correct in thinking that as long as the tran account is purely for deductible expenses it's find etc no personal expenses? i was thinking having 1 account for business expenses and 1 account for ip's expenses rates, water, insurance etc. would that be fine?

Cheers, Elives