Your opinion is appreciated - changing IP loan to home loan

Hi, PC members

Thanks for reading.

Currently I have an investment loan 480k (interest only until late 2022) with one IP and my home property combined as security with 65% LTV. The IP hasn't been performing very well and the outlook is not great either so I'm trying to offload it. Then I realised the home value has increased quite a bit and its own valuation most likely can support the loan by itself.

So I'm thinking to vary the security and basically take the IP out of this loan (requiring the valuation of my home property). By doing this, I'm hoping to achieve two goals.

With the title of the IP back to my own hands, its sales will not have anything to do with the bank loan so I will get all the payment for possible future investment without the need to completely pay out the current loan or refinance. I should still be able to claim any captical loss from the sales of the IP.

Also with the loan still there but only secured by my residential property, it effectively becomes a home loan with much lower interest rate. The downside I have to accept is any interest paid to the converted loan will no longer be tax deductable.

I would like to know if there is any potential issue with this plan. I'm also not sure if this will have any impact to the interest only period.

Appreciate your time.

 

So the idea is to keep the 480k loan and have it fully secured by your OO?

General comments:

1. You MAY be able to discharge the investment property security and have the loan fully secured by your OO. If the valuation is high enough and the lender allows it, it may be possible. Given the change in loan type, this may require credit approval (i.e. paperwork/servicing assessment). Some lenders charge rates on purpose, not security - so the rate may not fall either.

2. There may be tax consequences associated with this change (not my area of expertise). It will depend partly on how your current structure is set up for tax purposes.

 

Thanks, Redom. That was a very quick response. Yes, that is indeed the idea. With the extra funds, it is also possible for us to upsize when time comes without the need to get a new loan or refinance which may be very difficult in the medium term.

My loan is with Westpac and I've checked with them about the feasibility as well. My understanding is the it will change to their home loan rates. Only the revaluation of my OO is requried.

I don't think our finance structure is very complicated. Single income with family/kids benefits, some investment, super. The tax deduction from the IPs are pretty much all the standard. So with my limited knowledge, I can't see any other tax consequences with this change other than the loss of the tax deduction on the cost of the loan.

Really appreciate your help.

 

Most banks would simply look at this proposal and say that the purpose of the loan is still investment and thus continue to classify and price it as an investment loan. I'm not sure what Westpac will do, but I wouldn't be confident that they'll pricing it as owner occupier.

Also when you sell the IP, you might be able to keep the 'investment loan' open, but it's probably not going to be tax deductible. It would be prudent to pay off the investment loan when the IP is sold.

 

Thanks, Peter. That's very helpful.

I think in terms of the timeline, the variation on the security will happen first. Then the settlement of the IP sales. So my understanding is technically the Investment Loan will be changed to home loan before the IP gets sold. But as you said, the bank probably won't allow it. I'm expecting the cost on this loan will be tax deductible anymore after the change fo the security. However, it is disappointing if the rates still stays the same given the only seucirty in the loan will be our residental property.

 

Changing security doesn't effect deductibility of interest generally. But don't be too hasty to pay off the loan as you can reuse it

 

Yes,Terry, hopefully I can achieve either keeping it still as Investment loan and obviously still enjoying the tax deduction or changing it to home loan with much lower rates. Keep the loan there so I can reuse the fund from selling the IP. I can always pay off the loan later if I have to. Appreciate your thoughts.

 

Hi Ben,

Westpac will generally not change the IP loan into a OO loan.

When you do sell the property, the IP loan will no longer will be tax deductible but the best way forward is to create a new account with Westpac and offset the IP loan. Dump the funds against that loan, being interest only, no repayments and with the rest, offset against your home loan.

DO NOT COMBINE YOUR IP AND OO loan to get a lower rate on the IP loan as you can offset it with the funds. This way you can keep the cash, offset the interest and if further down the track you want to close the loan, you can.

 

Refer Terry’s commments above - this would appear to be incorrect on info provided and a bad idea.
Generally, if the OO loan has a higher after tax cost it is better to offset this first before IP loans even if the IP security has been sold.

 

Thanks Craig. The OO loan would have the same after tax cost as the IP loan if he has sold the investment property due to no available deductions.

If you have sold the property that you financed through a loan, you no longer have an income producing asset that you can offset the investment property loan against. So the interest for the investment loan is no longer tax deductible. If you have owner occ loan which is not longer tax deductible then you offset the loan with the higher interest rate which will be the investment loan 99% of the time.

Because it's interest only, you can park 100% of the loan amount in the offset account against the investment loan, not pay any interest and have cash sitting there available to use. Any remaining cash from the sale then offsets the owner occ loan.

 

The issue is your assumption of non-deductible once the asset is sold. This is not necessarily correct.

The rest of your points are fine if it was non-deductible.

Refer to Terry’s tax tips as I’m sure he’s covered this.

 

In the case of a loan to purchase an investment property, once the asset is sold, you cannot tax deduct a loan that was used for the purchase of that income generating asset as you no longer have it. That is Tax 101. It's not an assumption, it's the law.

Otherwise, there'd be a lot of people tax deducting debt that was used to purchase an asset but sold off. Individuals, companies, trust and every other investment vehicle under the sun would do this.

 

You sound like you must be a mortgage broker.

What if the asset is sold at a loss?

What if the income generating asset was sold and the loan reused to purchase another income producing asset?

 

Terry,

As per the purpose test, once the asset is sold, you cannot claim interest deduction on the loan that was used to acquire it. If the property was sold at a loss, you bank the loss against future capital gains.

If the income generating asset is sold and you completely offset the investment loan, then pull that money out of the offset to purchase a new investment property, you can use the accruing interest from the investment loan against the new property.

It comes down to the purpose test.

David

 

David, the ATO disagrees with you there.

2nd paragraph is correct.