The ideal Loan Structure where the first property is an investment One general rule to keep in mind when structuring things is that you should maximise deductible debt while minimising non-deductible. This is because of the tax savings. This makes sense where there is a main residence loan and investing, but it also makes sense where someone has no non-deductible debt as they should still aim to maximise the deductible debt so that they can use their cash for pleasurable pursuits and/or the future purchase of private assets. Example Deng lives with his parents and wants to buy an investment property. He has $200,000 cash and wants to buy a $500,000 property. Most people would say debt is bad and that he should put down a large deposit to reduce the amount of debt. But if he does this it will cost him dearly in extra non-deductible interest if he ever were to buy a main residence. For more on this see Tax Tip 60: Never use cash to invest So how should Deng structure his loan? Option 1 Ideally he should borrow 105% of the purchase price. He can do this in a few ways, but the ideal would be to borrow 25% from his parents. His loans would look like this Loan 1 $400,000 Interest Only with offset with say CBA Security would be IP 1 only (80% LVR) Loan 2 $125,000 Interest Only. Lender would be parents (or anyone else) Security would be unsecured or 2nd mortgage over IP 2. This is the preferred method as there are no cross collateralising issues and the risk is reduced for the parents as all they can lose is their money lent and not their property. It is also cheaper and easier to set up. Once the property increases in value Deng can increase the $400,000 loan with CBA to $525,000 and use the $125,000 to repay the parents. This is refinancing one loan with another and provided the loans are set up at arms length and commercially the interest should still be deductible on the full loan. Deng needs Tax advice. Option 2 The next best alternative would be to use parent’s property as additional security. Deng would then keep his cash in the offset account. In total, in this example, Deng would borrow Loan 1 $525,000 Interest Only with Offset Security would be IP 1 plus parent’s property. Parents could gain some comfort that Deng would be able to pay the loan down to 80% LVR when needed and have the bank remove their property as security (but this doesn’t mean he will). Once Deng’s IP increases in value he can apply for a ‘release of security’ and have the parent’s property removed Option 3 Another alternative would be for Deng to set up the $200,000 cash as a term deposit and then use this as security for the loan and borrow 105%. Actually he would not need to keep all this money in the term deposit but just $125,000. His loan would look like this Loan 1 $525,000 Interest Only with Offset Security would be IP 1 plus Term deposit of $125,000 This is not ideal as the term deposit would pay about 3% yet the interest on the loan would be about 5%. It is debateable whether the deductibility would be denied on this portion too as it is not a commercial way to do things. This will also be difficult to set up. If it can be done then when the property grows the term deposit can be released as security – and then use for the future main residence purchase. Goals with all these? The goal with all of these options is to borrow as much as possible as this will leave more cash available for the future main residence. These strategies will maximise deductions while eventually minimising non-deductible interest. Please discuss.