Tax Tip 539: Refinancing a Loan – What does Refinance mean?

Discussion in 'Accounting & Tax' started by Terry_w, 6th Sep, 2023.

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  1. Terry_w

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

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    From a tax point of view, refinancing a loan means using one or more loans to pay out one or more other loans. It doesn’t necessarily mean ‘changing lenders’.


    Example 1

    Homer has a main residence and borrowed to buy it. He applied for a loan with ANZ who took a mortgage against this main residence to lent him $500,000 to buy a house worth $600,000.

    Later the rates with ANZ are not attractive so he refinances this loan with AMP Bank. AMP lend Homer $500,000 and he uses this to pay out the $500,000 loan with ANZ. ANZ discharge the mortgage and AMP lodges a mortgage over Homer’s house – to secure their loan to Homer.


    This is the most common way a ‘refinance’ occurs. But not the only way.


    Example 2

    Later Homer splits the loans with AMP so he has 5 splits of $100,000 each.

    He finds out he can get a lower rate with Macquarie. So, he refinances the 5 loans into 2 loans with Macquarie. One for $200,000 which relates to the portion of the loan that was used to purchase the property originally. And the other for $300,000 which relate to the 3 x $100,000 loan splits which Homer used to buy income producing shares using the debt recycling strategy.

    This is a refinance 5 loans have been refinanced by borrowing from Macquarie to pay out AMP.

    In addition, Homer borrowed another $100,000 from Macquarie to buy a boat – this is not a refinance but is new borrowings.


    Example 3

    Homer has built up $200,000 cash and doesn’t want to invest anymore. He is paying 6% pa with Macquarie while he is paying 7% p.a. on his $200,000 loan with CBA which was used to buy an investment property. To get a lower rate on this Homer takes his $200,000 cash and pays it into his $200,000 loan split and redraws it and pays it into his CBA loan. This is a refinance, without changing mortgages, as one loan has been used to pay another loan. He hasn’t changed banks, but he has shifted deductibility from the CBA loan the Macquarie loan.

    Deductibility is not lost either because the $200,000 Macquarie loan was used to refinance the $200,000 CBA loan and this was used to buy the investment property. This means the interest on the $200,000 Macquarie loan will be deductible.


    But it isn’t necessary to pay out the whole loan. Part of a loan can be paid out.


    Example 4

    Imagine Homer wanted to keep $60,000 cash as a buffer. In example 3 above he could have just split the Macquarie $200,000 split into 2 portions

    a) $140,000, and

    b) $60,000

    He could have then paid $140,000 into the $140,000 loan and redrawn and paid this into the $200,000 CBA loan. This would result in the interest on the $160,000 Macquarie loan being deductible plus the interest on what is left in the CBA loan, being $60,000, as being deductible.

    The benefit is that Homer is getting a 1% interest rate saving on $160,000 of the investment property loan – saving him around $16,000 per year.


    Get your own tax advice before trying this at home as it is easy to stuff things up.


    See related post

    Tax Tip 488: Redrawing from One Loan and Paying into Another is Refinancing Tax Tip 488: Redrawing from One Loan and Paying into Another is Refinancing
     
  2. Paul@PAS

    Paul@PAS Tax, Accounting + SMSF + All things Property Tax Business Plus Member

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    Many who refinance often get encouraged to blend and combine loans rather than retain splits etc. There are a lot of warnings to this practice. Even minor things can be a issue
    And even aftre refinance things can change and affect deductibility

    eg Fred has three loans of L1 $125k, $L2 100K and L3 $295K. lender says - We can offer two loans - One of $300K and the other $230K So they refinance L3 as $300K and L1/2 as $230K
    So the$300K loan is now 5/300 = 1.666% non-deductibe and the $230K is 5/230 = 2.17% non-deductible. .. Forever unless the new borrowing sum is carefully used to pay some specific property outgoings.

    Why ? Because a refinance must discharge the exact sum and cant be higher...and shouldnt be lower either. And when you blend loans it can leave loans crossed and other factors. . And if its lower you lose deductibility. If the extra loan covers costs to refinance it may be OK. Lenders wont want a loan approaval for $298,756 but will approve a little higher and this can create all sorts of issues. Espe when they dump the extra cash into your savings account. This is a key matter the ATO are llooking at now. They seek to contninually trace all loans from day 1 through to the present and any debits or changes to the loan amount must be proven.
     
  3. Rolf Latham

    Rolf Latham Inciteful (sic) Staff Member Business Plus Member

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    Given that one wont know what the payout figure for a refi will be, whats the best practice method from a tax accounting perspective please, being mindful that lending like this works with data to be set in the future, rather than historical.

    Lenders will do a loan approval of 298 756, but the settlement loan amount will be different 99.99 %of the time.

    ta
    rolf
     
  4. Terry_w

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

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    It will never work out because of the incurred but uncredited interest which is added at the end, but best to go as close as possible
     
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  5. Paul@PAS

    Paul@PAS Tax, Accounting + SMSF + All things Property Tax Business Plus Member

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    Esp when rounding is considered. If accrued interest is refinanced the capitalisation is a one off and immaterial really and would pose no concern as it is produced by the lender rather than through any taxpayer actions. Part IVA capitalisation usually considers taxpayer acts that are in the manner of a scheme. It wont pass that test.

    Break fees can also be in there and wouldnt be a issue. The real problems ones are where there is extra $$$. In such cases it can be wise to recredit the loan to remove the mischief. Then this may show as a new redraw balance and the taxpayer may even be able to use that for the same property outgoings. Its a common question I get asked...what do I do with the extra $$.
     
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  6. Argh&Ermh

    Argh&Ermh Member

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    Hi Terry,

    just checking ~ in example 3, where did the $160,000 balance come from, is this supposed to be 140,000 and 14k interest savings respectively?

    Great advice as always,

    TIA



     
  7. Terry_w

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

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    I didn’t mention $140,000 in example 3, did you mean example 4?

    It seems Homer wanted to keep $60,000 cash as a buffer and had a $200,000 loan so 200-60 = 140
     
    Argh&Ermh likes this.

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