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Terryw’s Ideal Loan Structure

Discussion in 'Property Finance' started by Terry_w, 14th Nov, 2015.

  1. Terry_w

    Terry_w Solicitor, Finance Broker, CTA Business Member

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    Terryw’s Ideal Loan Structure

    Sorry for the length of this one.

    The basic case for a person with an existing main residence with equity


    The general rules are:

    1. Never cross collateralise.

    2. Offset account on the main residence.

    3. Access equity via a separate loan split secured by the main residence.

    4. Borrow 80% or 90% against the new property secured by the new property only.

    5. All incomes into the offset.

    6. Use a credit card to pay for all expenses.

    7. Extra strategies can be implemented as required.


    This is generally how I set up loan structures for clients. All the extras don’t suit everybody, but where they can be included it can get you saving more much quicker.


    Example of Tom and Jerry

    Tom and Jerry are joint owners of 123 Smith Street. They purchased it for $400,000 and have a $300,000 loan outstanding. They have never redrawn from the loan, but had paid it down from $350,000 which was the starting point. It is a PI loan, but they don’t have an offset. The property is now worth $800,000.


    Step 1 Calculate Potential available Equity.

    The first thing to do is to calculate potential available equity.

    (Valuation x 80%) less existing loans = potential available equity

    $800,000 x 80% = $640,000. But existing loan is $300,000. That means they could potentially get access to another $340,000.

    I say ‘potentially’ because they still need to apply and demonstrate serviceability. Some lenders will also be worried about ‘cash out’ of such a large amount.


    Step 2 Set up a loan to access the equity

    The loan to access equity will need to be at the same lender as the main loan. This is the ideal time to change lenders if you need to and/or change products.

    They would approach their lender or broker and say they want their loans structured as follows:

    $300,000 as PI or IO Lets call this Loan A Security is PPOR

    $340,000 as a LOC or IO loan Loan B Security is PPOR

    Loan A would generally be PI as these days you can get lowers rates with PI and/or there will be lender restrictions. But IO would be ideal, especially where this main residence could become an investment property at some point in the future.


    Loan B would generally be a LOC. But these tend to have higher rates and the loans are at call with some lenders. This is not ideal, so where it is possible to use an IO loan in a manner similar to a LOC I think the IO loan would be better. Ideally you would want to be able to transact from the loan itself. You should not need to transfer money from the loan to a cheque or savings account to pay a bill. See tax tip 1 for reasons.


    At the same time Tom and Jerry would make sure they have a 100% offset account attached to Loan A. Loan A is not investment related and the interest on this loan will not be deductible while they are living in the PPOR so the offset account should be attached to Loan A. All the wages of Tom and Jerry should go into this account together with any spare cash they have lying around. Any lotto winnings, inheritances or other money should be deposited into this account as soon as received. Some people get their wages paid into another account and then transfer it over, but this will cost you more interest as interest is calculated daily so get it paid straight into the offset account asap.


    Never redraw from the main loan, Loan A. Even if redraw is available do not be tempted to use it because that will mix the loan and create a tax mess if the PPOR is ever rented at some point in the future.


    Step 3 The Investment Property Loan

    Once you have Loan B set up you can then go and find an investment property. It is important not to pay any deposits etc before you set up loan B as the deposits need to be paid with borrowed money, which ideally should come from loan B. if you pay a deposit with cash you would have just lost a large ongoing tax deduction.


    You should also have a pre-approval of confirmation from a broker that you should be able to borrow for the purchase. Also get legal advice on whose name the new purchase should be in before you go and sign contracts.


    Once you have found an IP you wish to buy you should apply for finance. The finance for the IP should generally be 90% or 80% of the purchase price.


    In this example Tom finds a $400,000 property and he applies for a $320,000 loan.

    $320,000 interest only Loan C Security is IP only


    The other $80,000 to complete the purchase would come from Loan B as would money for the stamp duty, conveyancing fees and other costs – usually 5% or so of the purchase price –see below.


    Step 4 Paying Deposit

    The 10% deposit for the IP should be paid for from Loan B. Don’t let the money make any detours. Pay the agent’s trust account directly from the Loan B.

    Don’t use cash to pay for the deposit

    See Tax Tip 53: Paid Deposit with cash - how to fix big mistake before settlement


    Step 5 Paying Stamp Duty

    Stamp duty will also be payable before settlement. Tom should borrow the stamp duty fee from Loan B. He should not use his cash as that would cause him to pay more interest on this PPOR loan


    Step 6 Paying other costs

    Any other costs incurred that are associated with this property such as building and pest inspections, depreciation reports etc should be paid for from Loan B.


    Step 7 Settlement of the IP

    Just before settlement any extra funds needed would be supplied to the conveyancing solicitor either in the form of a bank cheque or via a transfer to their trust account. This money should come from Loan B as well – make sure there are no detours. If there must be a detour make sure there is an empty account to deposit the money into and then transfer it out. This will avoid mixing borrowed and non borrowed money.


    After settlement Loan B in this case would have a limit of $320,000 but would be drawn to approx. $100,000 ($20,000 for stamp duty and costs and $80,000 for the deposit).


    Step 8 Start Collecting Rent

    All the rent from the new property should be paid straight into the PPOR offset account. There are no tax reasons to segregate this money into a separate account. In fact there are tax reasons not to as you would end up paying more non deductible interest on the PPOR loan (Loan A) if you did.


    Step 9 Consolidate debt on the property it was used for

    In these steps you will have a debt for the investment property secured by the main residence. Security doesn’t determine deductibility so this is not such an issue, but I think as the IP grows in value it would be good to increase the loan on the IP itself and then use these extra borrowings to pay down Loan B. My reasoning is outlined in Tax Tip 36: Consolidating Loans for investment properties


    In this example Loan B started off at a $0 balance but ended up at $100,000 owing by the time of settlement. Total money borrowed relating to the investment property would be

    $320,000 Loan C

    $100,000 Loan B

    ----------

    $420,000

    ----------


    $420,000 divided by 80% = $525,000


    Therefore once the property had grown in value to $525,000 it would be a good idea to increase the loan on this IP to 80% of $525,000 which would be $420,000.

    The current loan is just $320,000 so that would be borrowing another $100,000. This extra $100,000 would be paid back into the LOC to bring the balance to $0. All the debt relating to the IP would now be secured by the IP and it would be just one loan. Nice and tidy. But the additional benefits are that the LOC is clean to use again for the next property.


    Another benefit is that if the PPOR was ever sold the Loan B would need to be paid out and paying it out would mean no further deductions. So best to move it over to the IP as security as soon as possible.


    Summary of loans

    Loan Security Loan Type Deductible against?

    Loan A PPOR IO or PI Not deductible

    Loan B PPOR IO IP

    Loan C IP IO IP

    Offset No security.

    Linked to PPOR n/a n/a
     
  2. Terry_w

    Terry_w Solicitor, Finance Broker, CTA Business Member

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    Optional Strategies

    Split the investment LOC

    Where there will be a large LOC loan – Loan B in this case you should consider splitting it up from the start. This will enable you to buy a second property without mixing the LOC. It could be split later but keep in mind it may not be possible to split if servicing cannot be demonstrated with some lenders. See Tax Tip 13: Simple Loan Structuring Strategy


    Split the Main Loan

    Where the equity in the PPOR is on the low side then consider splitting the main loan – Loan A in this case. This will allow one of the loan splits to be paid off quickly and then that split could then be used to invest. This will avoid the need to approach the lender again to split the loan down the track.


    Borrow to pay investment expenses

    It can be possible to borrow to pay investment expenses such as rates and insurances. Don’t do this without tax advice

    See Tax Tip 4: Borrowing to Pay investment expenses


    Borrowing to pay investment expenses means you have more money sitting in your offset account helping to pay off your non-deductible home loan sooner.


    Use a Debt Recycling Strategy

    See Tax Tip 6: Using Redraw to invest

    A debt recycling strategy would include borrowing to pay investment expenses, but it may also include borrowing to invest in other assets such as shares. This can be potentially dangerous so seek financial advice before implementing.


    Use Credit Cards

    Using an interest free period credit card can mean the payment of your expenses is delayed and this allows for your money to stay in your offset account longer. This will save you non-deductible interest.

    Make sure you pay the credit card off each month or before the required payment date otherwise you will be paying interest. The money to pay the credit card should come from the offset account - except where you are doing the debt recycling strategy - see the tax tip 12 linked below..

    You may also get points on your card which may mean money back or other savings or free gifts. The more properties you have the more opportunities you get for earning points. But just make sure the benefits outweigh the costs of the card.

    There are also potential tax issues with using a credit card to pay for property related expenses and then borrowing from your LOC B to pay for these expenses. See
    Tax Tip 12: Credit Cards and Tax Issues
     
    Last edited: 18th Nov, 2015
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  3. Terry_w

    Terry_w Solicitor, Finance Broker, CTA Business Member

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    The formating of the table I did at the end of the first post didn't work. I have attached a PDF of the document which may look nicer. Please see attached.
     

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  4. euro73

    euro73 Well-Known Member Business Member

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    +1. Loan structuring is key. This is how I teach clients to do it
     

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    Last edited: 14th Nov, 2015
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  5. Wukong

    Wukong Well-Known Member

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    Thanks. Very well written
     
  6. Bayview

    Bayview Well-Known Member

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    Terry for PM:cool:
     
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  7. Angel

    Angel Well-Known Member

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    Thank you Terry, great post.

    Do you mean to say: $420ooo is 80% of $525ooo ?
     
  8. brisfisher

    brisfisher Member

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    very informative. thanks
     
  9. Coota9

    Coota9 Well-Known Member Premium Member

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    Great post!!
     
  10. Terry_w

    Terry_w Solicitor, Finance Broker, CTA Business Member

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    Dividing the current loan amount by 80% allows you to determine what the valuation needs to be to get an 80% LVR.
     
  11. sandyfeet

    sandyfeet Well-Known Member

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    Great post thanks Terry,

    You note that when the PPOR is sold that loan B would need to be paid down. I understand this means you lose deductibility. Does this also result in less 'cash' available for a future PPOR meaning you would take on a larger non-ded loan?

    Is it possible to transfer the security of loan B to a new PPOR?

    Thanks,
     
  12. Terry_w

    Terry_w Solicitor, Finance Broker, CTA Business Member

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    Yes security could be substituted - another property or even cash could be used (temporarily).

    see
    Tax Tip 74: Selling a property that secures other loans
     
  13. sandyfeet

    sandyfeet Well-Known Member

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    Ok got it thanks, is there a limit to the time that a bank will allow a term deposit to secure a LOC?

    Referring people to you 'tips' must save you a lot of time :) very useful!

    Thanks
     
  14. Terry_w

    Terry_w Solicitor, Finance Broker, CTA Business Member

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    It should only be considered a temp measure as you would be paying about 5% interest, but only getting less than 3% on the term deposit so you would be losing money. But I am not sure if there are any time limits imposed by banks.

    Yes the tips save a heap of time and duplication. I keep a spreadsheet for easy reference.
     
  15. Moist

    Moist Well-Known Member

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    Terry, can you write a similar post for self employed people who buy and trade through separate discretionary trusts? I would imagine there would be a fair few on this platform.
     
  16. D.T.

    D.T. Adelaide Property Manager Business Member

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    You still have income that should go to PPOR's offset account whether that's PAYG or SE as the source.
    The rest is the same, isn't it?
     
  17. Terry_w

    Terry_w Solicitor, Finance Broker, CTA Business Member

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    Yes I think DT is right. What differences would there be?
     
  18. Terry_w

    Terry_w Solicitor, Finance Broker, CTA Business Member

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    Or do you mean having a trust held property and loans?
     
  19. Moist

    Moist Well-Known Member

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    yes I am referring to trust held property and loans. For instance, say you run a business through a trust with a bank account for this trust. If you put excess money into the PPOR offset (which is in your individual name), are you not then paying yourself as an employee of the business or otherwise making a director loan account?
     
  20. D.T.

    D.T. Adelaide Property Manager Business Member

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    How would that business normally pay you? Does it pay you a wage?