The ideal loan structure for someone who has paid off the main residence

Discussion in 'Property Finance' started by Terry_w, 29th May, 2016.

Join Australia's most dynamic and respected property investment community
  1. Terry_w

    Terry_w Mortgage broker licenced 4 tax/legal advice Business Member

    Joined:
    18th Jun, 2015
    Posts:
    18,774
    Location:
    Remote
    The ideal loan structure for someone who has paid off the main residence


    I have written a thread on my idea of the ideal loan structure here Terryw’s Ideal Loan Structure


    Where someone has already paid off their main residence the ideal loan will be very similar to the one I have described in the thread above. But there are slight differences so here is another ‘ideal’ structure.


    Should the loan be PI or IO?

    Normally you would have an IO loan on an investment property. One of the main reasons would be so you can divert extra funds to the non-deductible PPOR loan. In this case, there is no non-deductible debt so this is not such an issue.


    However going IO may be better still for a number of reasons such as:

    - You may want to upgrade the main residence at some point and need cash

    - You can still pay the loan as PI and revert to IO if or when you want

    - You will still save the same amount of interest

    - You could retire earlier and use the offset to live on and this would be more tax effective


    But paying PI may be beneficial where:

    - The lender differentiates on rate

    - Serviceability is an issue

    - You are tempted to spend large sums of cash


    Ownership Structure should also be considered

    A simple example is buying one property in the name of spouse A and another in the name of spouse B. Money can then be moved between offsets as circumstances change so as to get the best tax position.


    Deposits

    You might save up enough cash in an offset (on one IP) to be able to pay a 20% deposit on the next property. Taking the cash out of the offset would have the same tax effect as setting up an LOC on an existing property and borrowing the deposit. But there are longer term aspects to consider.

    Having large sums of cash in offset accounts would be better for retirement. You could use the money to pay for private expenses and the interest on the loans would increase and this interest would be deductible. So indirectly you are borrowing to fund private expenses and the interest will be deductible.


    This can allow retirement to be brought forward compared to using cash as deposits.


    In summary, my ideal structure is:

    PPOR paid off

    LOC secured against the PPOR

    LOC split into relevant portions


    LOC portion A used for IP 1 deposit and stamp duty etc.

    80% of IP purchase borrowed from a lender (ideally separate lender to the LOC) and be IO. Offset account attached to this.

    One owner of this property.


    LOC portion B is used for IP 2 deposit and stamp duty etc

    80% of IP 2 purchase borrowed from another lender.

    If this property is owned by the same person as IP 1 there is no need for an offset account. If owned by the other spouse an offset may be needed.


    LOC Portion 1 should be converted to a term IO loan once the IP1 has settled – because the rate will generally be lower and you will get a term loan instead of a loan at call. It will also help for servicing.


    Once IP 1 grows in value the amount used the LOC portion A should be borrowed by increasing the IO loan


    Example with figures

    Frank has a $500,000 PPOR fully paid off.

    He sets up a $400,000 IO loan with Westpac – which can be used just like an LOC. (Loan 1)


    He then goes out and finds a nice IP (IP1) for sale for $500,000.

    He goes to ANZ and borrows $400,000 (Loan 2), IO with an offset

    And uses $140,000 from Loan 1.


    Once IP 1 settles he arranges for the Westpac loan to be split as follows:

    Loan 1a $140,000

    Loan 1b $260,000 (unused)

    No need to convert the LOC into an IO loan because it already is one. But if he went to another bank he would have converted it.


    Mrs. Frank decides to buy a property now, IP2 for $500,000

    Mrs uses $140,000 deposit from Westpac’s Loan 1b.

    $400,000 is borrowed from CBA as an IO loan with an offset.


    Frank had saved up $100,000 in the offset against Loan 2, but Mrs Frank has a lower taxable income than Frank so he transfers the $100,000 into her offset. This results in more income being generated from her property (as there are fewer costs due to the lower interest incurred). Mrs pays less tax on the income than Frank would.


    By this time, Frank’s property has jumped in value to $700,000. 80% of the value is $560,000 so Frank increases his loan with ANZ from $400,000 to $540,000 and he uses the extra $140,000 to pay off the Westpac loan 1b. This loan can now be used for the next IP deposit. It also brings all the debt associated with the IP1 property into one loan which makes it more administratively convenient.


    They may buy a few more properties along the way using the same structure as above.


    After a while, they may now have, say, $500,000 saved up in the offset account against the two properties. They want to buy a new property for $500,000. They could just pay cash. But if they decided to borrow 105% as above.


    They now realise their income from rent is approx. 70% of what they need to reach their goal of giving up work. Instead of working another 5 years, they decide to stop work early. They live on rents and use their offset cash to pay for the rest of their living costs knowing that every time they buy groceries the interest on their investments increases and so does their tax deductions. This lessens the cost of retirement. Every 12 months their rents increase and their offset account doesn’t drop much at all. They can keep it there was a buffer while living on the rents and have a passive income which grows faster than inflation (hopefully) as well as the capital base also growing faster than inflation.


    Each year they move the cash in the offset around so that they end up with taxable income the same as each other as this will result in the least tax being payable.
     
    meni, MWI, LoanSharkJR and 10 others like this.
  2. Sheeky

    Sheeky Member

    Joined:
    30th Mar, 2017
    Posts:
    11
    Location:
    Sydney
    Great info! Thanks!

     
  3. teetotal

    teetotal Well-Known Member

    Joined:
    7th Nov, 2015
    Posts:
    730
    Location:
    Sydney
    Terry, How would a PPOR completely paid off compare with PPOR loan offset full of cash ?
    Much difference or same outcome?
    Especially if Frank plans to turn PPOR to an IP in future.
     
  4. Terry_w

    Terry_w Mortgage broker licenced 4 tax/legal advice Business Member

    Joined:
    18th Jun, 2015
    Posts:
    18,774
    Location:
    Remote
    Huge tax difference.

    Example
    $500,000 IO loan on main residence with $500,000 cash in offset. The loan relates solely to the purchase of the property.

    Owner decides to move out and rent the property and buy a new property to live in. She does this and takes her $500,000 from the first offset and puts it into a new offset linked to the new loan.

    Result is $25,000 per year interest on the first property (at 5%) which is now deductible.

    If the first house was fully paid off - no interest to deduct PLUS $500,000 more loan for the new property = $25,000 in interest which is not deductible.
     
    teetotal and EN710 like this.
  5. teetotal

    teetotal Well-Known Member

    Joined:
    7th Nov, 2015
    Posts:
    730
    Location:
    Sydney
    Makes sense.
    If plans are to move out of PPOR at any point in future then its better to just use offset rather than paying off. Good strategy.
     
  6. highlighter

    highlighter Well-Known Member

    Joined:
    2nd Jun, 2016
    Posts:
    761
    Location:
    Australia
    Very interesting, thanks Terry.
     
  7. Terry_w

    Terry_w Mortgage broker licenced 4 tax/legal advice Business Member

    Joined:
    18th Jun, 2015
    Posts:
    18,774
    Location:
    Remote
    Well it depends. Perhaps not if your cash levels are low because you won't have much in the offset and the interest rate will be high for IO.

    Also many people won't be able to service if they keep the old main residence so they may have to sell. In that case paying it down may not be an issue.

    You have to adapt to the changing times.
     
    teetotal likes this.
  8. hash_investor

    hash_investor Well-Known Member

    Joined:
    11th Oct, 2015
    Posts:
    1,889
    Location:
    Sydney / Canberra
    what if you have only one spouse?
     
    teetotal likes this.
  9. Terry_w

    Terry_w Mortgage broker licenced 4 tax/legal advice Business Member

    Joined:
    18th Jun, 2015
    Posts:
    18,774
    Location:
    Remote
    try the app called 'extra spouse'
     
    Zoolander likes this.
  10. MWI

    MWI Well-Known Member

    Joined:
    17th Jul, 2017
    Posts:
    594
    Location:
    Lower North Sydney NSW
    Hi Terry,

    Great read. It provides flexibility, portability and choice, hence for that reason I have actually utilised this....and it works for me wonders! In addition, since I pulled out the equity, my PPOR has grown by another 50%.
    I must say I have used such an approach, a bit more complex then your illustration above but yes I decided few years back (thanks to you ALL on Somersoft property forum who had me inspired to do more) why not utilise the PPOR funds (it was 100% paid off in well located expensive area), as the deductibility depends on what you wish to use it for? In addition if you don't use it you do not pay the interest, like a large credit card?
    The broker said I would never pull out that much equity now (I also refinanced 2 IPs loans), hence it was just sitting there for my need.
    Now I had split the loans into 9 for my needs (3 IPs LRBAs borrowing, 1 IP Trust borrowing, 1 IP family member borrowing, 3 personal funds sitting there - can be utilised for further investment or to live off, 1 personal funds as a buffer).
    It is also beneficial to use offsets since we have the control to pull out the funds for whatever we need, wether to accumulate more or to then live off, rather than to go back to the bank and ask them for valuation and see how much they will give you!
    I just thought I had so much funds sitting in PPOR why not utilise it while it was still possible?
    Even though your example is great, my portfolio, was much larger than that and the financiers will look at the overall portfolio though and serviceability will be the key!
    I must point out that discipline is required in such an approach so nobody uses these funds as a credit card to spend. In addition I have the flexibility to fix interest on them.
    So if any have their PPOR, they may wish to think to pull out the equity but I must stress it is not for the faint-hearted!
    Also, I should point out I do not plan to move, as this was my PPOR I downsized to (in metres squared not in cost!), hence it suited my situation.
    I suppose again it offers choice down the track, whether to supplementing living off equity too, although I am reluctant reduce the pile....
     
    josh123, LoanSharkJR and Terry_w like this.
  11. LoanSharkJR

    LoanSharkJR Well-Known Member

    Joined:
    22nd Jul, 2016
    Posts:
    90
    Location:
    Melbourne
    Oh this sounds like just what I have been looking for...thanks Terry
     
    Terry_w likes this.
  12. pippen

    pippen Well-Known Member

    Joined:
    10th Aug, 2016
    Posts:
    590
    Location:
    australia
    Is it at all possible for a period who has a p and I no frills hone loan with only redraw to approach the bank and change the conditions of the home and get a full offset attached and if so any ideas how much they the bank would charge for these changes? or has that horse bolted?

    Cheers
     
  13. Terry_w

    Terry_w Mortgage broker licenced 4 tax/legal advice Business Member

    Joined:
    18th Jun, 2015
    Posts:
    18,774
    Location:
    Remote
    If that lender offers and offset account this is possible. But it cannot fix past mistakes.
     
    pippen likes this.
  14. MWI

    MWI Well-Known Member

    Joined:
    17th Jul, 2017
    Posts:
    594
    Location:
    Lower North Sydney NSW
    Great to re-read, thank you Terryw! Will probably need to sit down soon and see where I can restructure or pull out some securities instead.
    Have you written anything on exit strategies, when LVRs become low to pull out some titles or how to live off offsets. I would appreciate any strategies there.
    Currently have around 27% overall in LVRs and idea was to pay into offsets to pay off within 10-12 years but perhaps should utilize offsets to drawn down one day to live on, but then I wouldn't even spend that if I am talking in 7 figures. I suppose being self-employed and semi retired for the last 20 years I don't actually think of a particular day I need to just stop doing what I am doing if I like what I am doing.....?
    Hopefully have not confused you there...
    Your Tips with examples should be documented into a book Terry and you should sell it! Thank you for sharing!:)
     
  15. Terry_w

    Terry_w Mortgage broker licenced 4 tax/legal advice Business Member

    Joined:
    18th Jun, 2015
    Posts:
    18,774
    Location:
    Remote
    Hi MWI

    Generally you would delay selling as long as possible so you can squeeze out some more capital growth.
    To delay even further you could live on rents and borrow to pay the interest, potentially, getting more tax bang for your buck.
    Then ideally you might sell the main residence or an IP which you can claim the main residence CGT exemption or - or perhaps the property with the largest land tax bill.

    If you have a low LVR you can structure things so you can sell but keep the loan open and then recycle debt and use the loan to buy a new property.

    I have collected 50 of my tax tips and made them available as a PDF at PropertyTaxBook.com.au or Terryw's home page – Solicitor, Chartered Tax Adviser & Mortgage Broker
    and am working on making 3 more books on tax tips. But it is a lot of work editing and formatting.

    Also have been writing about 6 other books at the same time, but it is a long process.
     
    Francesco likes this.
  16. MWI

    MWI Well-Known Member

    Joined:
    17th Jul, 2017
    Posts:
    594
    Location:
    Lower North Sydney NSW
    Hi Terry,
    I have what you would actually call a self funded portfolio, quite large, hence no need to sell any at all, and could even duplicate if wanted to further.
    My dilemma is whether to always have some LVR or just be totally debt free? Like you pointed out could be borrowing more, or could actually live from offsets or rents or additional separate business income, then eventually from SMSF too, so having such choice is wonderful, I realize that.
    Have also started young adult kids on investment journey too and somehow I prefer that role better.
    No need to pay PPOR, have been paid off in full a while back, utilized leverage to invest further and for additional buffers, which could be utilized for living but no need at this stage.
    You see if one has a large enough self-sustained portfolio, it enables duplication just from that.
    So I suppose the question should be to ourselves what do we want in retirement, just keep duplicating forever with some low, say 20% LVR?
    Basically what I am asking is, what is your plan for retirement do you plan to keep doing what you are doing forever?
    Yes, writing books and editing takes time, especially for me since English was my second language, so when I pass my secrets to my close circle of family and friends I keep changing it all the time.
    I immensely enjoy reading yours as they make sense and the use of your examples... tells a thousand stories:)!
     
    Terry_w likes this.
  17. Terry_w

    Terry_w Mortgage broker licenced 4 tax/legal advice Business Member

    Joined:
    18th Jun, 2015
    Posts:
    18,774
    Location:
    Remote
    I see no reason to pay off loans just because you can. Personally I would do the opposite and keep paying the minimum possible.

    Just make sure this ties into your estate planning because under NSW law the debt goes with the property unless the will specifies otherwise.
     
    XBenX likes this.
  18. MWI

    MWI Well-Known Member

    Joined:
    17th Jul, 2017
    Posts:
    594
    Location:
    Lower North Sydney NSW
    That's what I thought keep in offsets, why pay off, then perhaps keep helping younger generation in the family to get ahead....
    Yes, estate planning all good and taken care of!
     
  19. ChrisP73

    ChrisP73 New Member

    Joined:
    5th Oct, 2018
    Posts:
    1
    Location:
    Brisbane
    Hi All - Recommendations for a good LOC (>750K) secured against PPoR that can be split into relevant portions which can be easily refinanced into IO loans? I'm currently with NAB with single LoC and two IO loans (fully offset) and looking at NAB portfolio package but it looks expensive. Anything under 4% for IO?
     
  20. pat_v

    pat_v New Member

    Joined:
    22nd Nov, 2017
    Posts:
    2
    Location:
    Melbourne
    My PPOR is owned outright but I'd like to buy a new PPOR (will need a loan) and turn the existing one into an IP. What's the most tax-effective way of structuring this?