Join Australia's most dynamic and respected property investment community

The ideal Loan Structure where the first property is an investment

Discussion in 'Property Finance' started by Terry_w, 4th Jan, 2016.

  1. Terry_w

    Terry_w Solicitor, Finance Broker, CTA Business Member

    Joined:
    18th Jun, 2015
    Posts:
    8,989
    Location:
    Sydney
    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.
     
    Numbers_man_numbers and Glorion like this.
  2. teetotal

    teetotal Well-Known Member

    Joined:
    7th Nov, 2015
    Posts:
    398
    Location:
    Sydney
    What if no rich parents around ? o_O
     
  3. D.T.

    D.T. Adelaide Property Manager Business Member

    Joined:
    13th Jun, 2015
    Posts:
    5,589
    Location:
    Adelaide, SA
    Use a personal loan :p
     
    teetotal likes this.
  4. Terry_w

    Terry_w Solicitor, Finance Broker, CTA Business Member

    Joined:
    18th Jun, 2015
    Posts:
    8,989
    Location:
    Sydney
    Option 3 - term deposit? Spouse. Friend.

    2 friends each having $200k could possibly lend $200k to each other.
     
    teetotal likes this.
  5. Terry_w

    Terry_w Solicitor, Finance Broker, CTA Business Member

    Joined:
    18th Jun, 2015
    Posts:
    8,989
    Location:
    Sydney
    I will write another one to cover the situation where it is no possible to borrow from relatives etc.
     
    teetotal likes this.
  6. teetotal

    teetotal Well-Known Member

    Joined:
    7th Nov, 2015
    Posts:
    398
    Location:
    Sydney
    Cheers @Terry_w
    That'll be great. I wanted to discuss about taking a personal loan as D.T mentioned but I'll wait for your post.
     
  7. Terry_w

    Terry_w Solicitor, Finance Broker, CTA Business Member

    Joined:
    18th Jun, 2015
    Posts:
    8,989
    Location:
    Sydney
    For someone who is buying their first property as an investment and they have no one they can borrow from, or parents with property, then there are limited options.

    Using their cash now will mean they will pay dearly for years to come. I had one client approach me who was living with parents and he had about 5 investment properties with which he paid cash deposits. He later realised that he had tied up a few hundred thousand tied up - I think $300k. Now he wanted to buy a main residence but had no cash to do so...

    Possible solutions:

    Option 1 The gift and borrow back strategy
    Deng has $200,000 cash. He gift this to either a parent or a discretionary trust which he controls. Once he has done that he can borrow from the parent or the trustee (cannot be himself as trustee). The loan will be at commercial arm's length rates and terms. Deng then purchases his property with 105% finance.

    Once capital growth kicks in Deng the refinances the $200k loan from his dad or the trust to a bank.

    A few problems with this - a) the ATO will possibly apply Part IVA to deny the ongoing deductions of the interest on the extra bank loan for the $200k as it is essentially Deng's own money he had borrowed. Generally other than for Part IVA it could work, so it would be worth applying for a private ruling to see the ATO's view - they may allow it. It would be more likely to succeed with Dad as the lender I think.

    Another problem, b) is that the Dad or the trust would receive income in the form of interest paid. Dad may give an interest free loan to avoid this problem, but this would create a further weakness in Deng's argument for the deductibility subsequence refinancing and ongoing interest.

    Giving away large sums of money is serious stuff, even if you are giving to 'your' trust so legal advice is essential before trying this at home. Other issues such as social security payments (dad's pension) can also be affected.

    Option 2: High LVR
    The less money Deng puts into his investment the more he will have for the future main residence. So he could borrow as much as possible - 95% or at least 90%. LMI will be incurred and this could be significant so Deng would have to weigh up the costs of the LMI compared to the potential savings in the future.

    Option 3 - Term deposit as security
    Discussed in the first post.

    These are the only options that I can think of at the moment.
     
    teetotal likes this.
  8. Elives

    Elives Well-Known Member

    Joined:
    19th Jun, 2015
    Posts:
    539
    Location:
    Queensland

    do you mean the 2nd mortgage would be over IP 1? (the investment property he's purchased)

    also with this loan arrangement (2nd mortgage) i thought the only lenders that would allow this would be lenders like liberty pepper etc, i thought big 4 banks would not allow this arrangement because the borrower does not have any "hurt money" in the deal.
     
  9. Terry_w

    Terry_w Solicitor, Finance Broker, CTA Business Member

    Joined:
    18th Jun, 2015
    Posts:
    8,989
    Location:
    Sydney
    Depends if the parents property is already mortgaged. If it is then yes. ANZ and major banks allow this. ANZ will allow it where the parents have their property mortgaged to another bank.
     
  10. Elives

    Elives Well-Known Member

    Joined:
    19th Jun, 2015
    Posts:
    539
    Location:
    Queensland
    is this only for arm's length situation? etc i know of a investor recently who sold a property with 2nd mortgage carry back but had to use i think liberty for the buyers and the buyers were on like 5.5%+ interest rate
     
  11. Terry_w

    Terry_w Solicitor, Finance Broker, CTA Business Member

    Joined:
    18th Jun, 2015
    Posts:
    8,989
    Location:
    Sydney
    These sorts of loans are known as 'family pledge' etc and are only for family situations. ANZ will take a second mortgage from non family members I think, but not for vendor finance deals.
     
    Elives likes this.
  12. Dwalsh

    Dwalsh Well-Known Member

    Joined:
    14th Dec, 2015
    Posts:
    73
    Location:
    Nsw
    I have done this, I have lost about 120k putting in cash deposits on some of my houses in early stages and hope to buy a ppor in 3 years or so but have cash money tied up in ip's.
     
  13. albanga

    albanga Well-Known Member

    Joined:
    19th Jun, 2015
    Posts:
    1,114
    Location:
    Melbourne
    Not that this is important but if you have a guarantor loan is it just part of a single loan split?
    As you mentioned just 1 loan for 525k.

    I thought it may be split 1 = 400k secured by first mortgage over property. Split 2 = 125k second mortgage over property.
     
  14. Corey Batt

    Corey Batt Finance Strategist Business Plus Member

    Joined:
    14th Jun, 2015
    Posts:
    1,167
    Location:
    Adelaide, SA
    Depends on the lender - some lenders such as ANZ will allow a single loan for a guarantor, whilst others such as CBA will require two seperate loans, one with two securities attached, the other solely for the purchase.

    For FHBer clients with no intention of investing - we will in many cases still set it up split as you've mentioned to work as a 'goal'.
     
  15. Terry_w

    Terry_w Solicitor, Finance Broker, CTA Business Member

    Joined:
    18th Jun, 2015
    Posts:
    8,989
    Location:
    Sydney
    At least you know now.
     
    Dwalsh likes this.
  16. Dwalsh

    Dwalsh Well-Known Member

    Joined:
    14th Dec, 2015
    Posts:
    73
    Location:
    Nsw
    Could I borrow to pay for all repairs and expenses and then keep as much cash as I can from the rents in a offset to maximise my cash to buy s ppor later on ?
     
  17. Terry_w

    Terry_w Solicitor, Finance Broker, CTA Business Member

    Joined:
    18th Jun, 2015
    Posts:
    8,989
    Location:
    Sydney
    Dwalsh likes this.