Renting out current PPOR and buying new PPOR

Hi all.

Long time listener first time caller

My wife and I are looking to rent out our current PPOR (2 bed unit) and upsize. As this was our first property, I feel like a deer in the headlights going through the scenarios.

Info:
- Unit is currently worth around $350,000 with $170,000 Outstanding Loan ($198,000 PI loan with extra payments of $28,000....I know, I know, not the best structure for tax etc), so we have considerable equity. (approx $180,000)

- We should get about $290 per week in rental (the unit next to ours was recently rented for around that)

- We would be looking at a new purchase price around $550,000

I have read we need to keep the LVR to 80%, so I think that means we can "draw" around $110,000 of equity form the unit for the new PPOR.

????? How then does the loan/loans - repayments look? ie I believe we would have a combined loan amount of $170,000 + $440,000 + stamp duty/taxes etc and that rental would help "pay" the original loan.

Is that right?

????? How best should we structure the loan? ie for best tax benefit/ most moderate repayments.

I appreciate your advice. I suppose I'm looking for some way of spitting out the final figures to weigh up the options.

Thanks.

Maybe there should be a common questions section in the forum.

combined loan amount of $170,000 + $440,000 + stamp duty/taxes etc

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If you redraw $110,000 from current PPOR, you are just shifting money, so combined loan will be $170,000 + $110,000 + $440,000 + stamp duty/taxes etc , Ie, the original $170K + $550K.

In addition, if you use $110K from the current PPOR to use for the new PPOR (personal use), the interest on this $110K will not be tax-deductible. It does not matter whether the old PPOR is converted to an IP.

Effectively you are taking out a non-tax deductible loan for the full $550K.

$290/wk rent for a $350000 unit is quite poor return for a 2 bedroom unit (4.3%). You should be getting at least $5.5-6% (~$370-400/wk rent).

Rather than making the whole $550K non-tax deductible, maybe an option to sell, then use some money to your new PPOR, and a better performing investment as well. Make the investment the larger of the loans.

Investor888 has some good points. The issues should be:

a. rental return
b. potential CG on the unit
c. cost of selling the unit and buying another IP

So in broad terms:

Existing Unit - $350K less mortgage $170K = $180K - Potential additional borrowing @ 80% LVR = $110K. As has been pointed out interest on this is not deductible. If you sell the unit you have commissions etc, say it costs $10K to sell. This means you have $170K deposit on your new place. Stamp Duty $20240, so say $150K to put down, means borrowings of $400K

This means if you want to stick to 80% LVR, and buy another IP you would borrow $40K from your new property, so potentially borrow another $160K for an IP. (this doesn't take into a/c Stamp Duty on your new purchase)

So Gross Assets = $550K new PPOR & $200K new IP = $750K
Borrowings = $440K secured on new PPOR & $160K on new IP = $600K
Net assets = $150K
Deductible borrowings $200K, non deductible $400K

Your proposal Gross assets = $350K Old PPOR + $550K new PPOR = $$900K
Borrowings = $170K old PPOR & $550K new PPOR & stamp duty $20K = $740K
Net Assets = $160K
Deductible borrowings $170K, nondeductible $570K

So the real issue is how can you make this work for you. On $290 per week your unit is probably almost neutrally geared.

Can you get good value on your 170K additional non deductible debt? This will depend on the Capital Growth prospects for your unit. Can you do anything simple to increase rental return and therefore value?

Now your unit is currently your PPOR, so you could potentially have up to 6 years after vacating it treating it as your PPOR which would mean Capital Growth would not be taxable. So assuming you pay interest at 6% on that $170K, if the unit averages growth in value of $10,200 a year you are neutral.

What do you do with your new "PPOR", then for the period the old PPOR remains your PPOR for tax purposes you add to the cost base interest on the non deductible $570K, rates, insurance, maintenance etc. So with the new "PPOR" as long as it is unlikely to increase by more than say $40K per annum on average in value you are in effect CGT free on that.

I'm currently going down your track, renting out old PPOR, using equity to borrow for new residence. My figures are a bit more promising. I'm grossing 6% rent on my old PPOR, and my additional non deductible borrowings compared to selling the old PPOR will only be $100K, meaning I only need my old PPOR to go up $6000 a year to be in front. However, we made a conscious decision to buy a PPOR that would be a good IP and have potential for extra capital gain, so we are actually cashflow positive on our old PPOR by $3K before non cash deductions.

It's an interesting dilemma. Selling reduces your equity so that you can't buy back an equivalent value property @ 80% LVR. I think I have better Capital Growth prospects with my old PPOR than my new "PPOR".

It's an individual answer and what is right for me might not be for you. I'm just demonstrating the process I went through in making my choice.

Depending upon your situation, you can have your cake and eat it too. However before I get into specifics, what are you hoping to achieve by keeping the unit? What is your goal?

I think Investor888 may have misread your post, the unit is currently valued at 350K, however based on the size of the loan unit was probably around the $220K mark when purchased, making 290pw rent in line with reasonable rental return.

Onto the explanation.......

Assuming that you and your wife are both on the title, one can gift the property to the other without attracting stamp duty on the transfer in Victoria. Seek legal advice regarding this point....it may cost you money, but it will be money well spent. Seriously.....get professional advice.

Assuming the above is still true your situation would work out like this

Refinance your current PPOR with an 100% offset IO loan for it's current market value, you say it's currently $350K. Assuming you borrow 80% you will have the following

Loan 1 - new IO loan - total value = 280K, 280K in offset
Loan 2 - old PPOR loan - total value = 198K

So, you then pay down loan 2, so that it is retired. You do this whilst this is still your PPOR.

You now have the following situation

Loan 1 = new IO Loan - total value = 280K, 82K in offset. This means you are only paying interest on 198K and sorts out your structure issue regarding tax.

So, now its time to go shopping and you have $82K you can use as a deposit. This means you could borrow up to roughly $320K on an 80% lend. Using your 80K offset money, you would have a value of approx 400K.

After you do this your situation would be as follows

Loan 1 - new IO loan - total value = 280K, 0K in offset - 100% tax deductible
Loan 2 - PPOR loan - total value = 320K, 0K in offset.

I highly recommend using IO loan with 100% offset on your new PPOR, so long as you are disciplined and pay in the same level of principle + interest payment to the offset each month, had this loan been a true P&I loan. This way you can repeat the above process should you move again.....and if your young you probably will.

Hope that helps out and welcome to the forum

the size of the loan unit was probably around the $220K mark when purchased, making 290pw rent in line with reasonable rental return.

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The historic rental yield is irrelevant. If someone bought a unit in 1980, they don't look at the rental yield as 30%, etc. What matters is what the current yield is, and whether you can use the money more effectively elsewhere.

I think you will find that Loan 1 is still not 100% tax deductible. Regardless of how you structure it, the simple fact is that he is still taking money would of the current PPOR loan to finance a new PPOR.

Ca[ptain woyuld be right thta with the exemption in duty in Victoria, his extra step would get another 90K of the borrowings tax deductible. You would need to do this while still in the unit to retain the PPOR CGT status of the unit. In New South we don't have that exemption which is why my wife and I didn't go down that track as the benefit:cost ratio wasn't in our favour with stamp duty

Yeah, your right jrc, the captain is right. My mistake. If it's refinanced and the money is sitting in the offset account that it won't affect the tax deductibility of the loan interest.

Hi Investor888. I also challenge your previous comment on historical rental yield. Yield is only part of the overall equation.

For example if I buy a house costing $100K on 100% finance and I rent said house out for a total rental of 5K per year, and I pay an interest rate of 10% on my finance then I have a 5% yield and a shortfall of 5K that I must pay for out of my own pocket. Lets leave depreciation out of this to keep the sums easy and the example simple. The loan is IO, so you pay off no principle

So then 5 years down the track the house has doubled in value and is now worth 200K, you now have a 100K loan, 100K of equity and lets say the rent has stayed the same, so you now have a 2.5% yield, which is terrible. However you have 100K equity, you control an asset worth 200K and it only costs you 5K per year to do so.

How is this a bad thing?

If you then refinance, sure you draw down funds and assuming you used said funds to buy another income producing asset with a decent yield, then you would be fine. The overall yield of the entire portfolio and ergo, the cashflow will improve

Focusing on yield alone is not as relevant with property as it is with shares, as the transactional costs of buying and selling are so much higher with property, Yield is only part of the equation. Yield will not make you rich, it's Capital Gains that make the money, yield keeps the cashflow alive and the whole ship afloat. Yield is important, but not the single yardstick by which you determine whether or not one particular property was/is a "bad investment".

So, LoungeLizard, a lot to digest here, lets hear back from you. What are you going to do.

I also suggest you talk to a good mortgage broker, and a solicitor regarding your particular situation in terms of the transfer. Many MB's post on this forum, after you do a bit of reading it will be apparent who they are.

the_captain said:

So then 5 years down the track the house has doubled in value and is now worth 200K, you now have a 100K loan, 100K of equity and lets say the rent has stayed the same, so you now have a 2.5% yield, which is terrible. However you have 100K equity, you control an asset worth 200K and it only costs you 5K per year to do so.

How is this a bad thing?

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Captain, Investor888 is saying that there is another house available for $200k that is currently yielding 5% (on todays value). Why would you hang onto your current house instead of sell it and buy the better yielding one?

Both would require $100k loan and $100k of your own money in it. One returns 2.5% while the other yields 5%. They both cost the same to hold.

Your argument that you only have to look at the historical yield is laughable at best...........

To the OP, you have to look at the current yield compared to other properties. If you don't you are costing yourself a heap of opportunity cost.

Gools

Gools,

My example isn't laughable, so I would suggest that you moderate the tone of your post, you may criticise my ideas and critique them, but at least provide a counter example to back up your claims. In both of my posts I have put forth clear and actionable information, what have you done?

I still stand by my post, and maintain that yield is not the single measure of a good or bad investment. No where did I say only refer to the historical yield.

Why wouldn't I use my equity to leverage into the $200K house now yielding 5%, why would I sell property one that I paid $100K for and forgo all of the capital gain and benefits of compounding.

Sure, if I sold the $100K place, bought the $200K place on 50% LVR and kept repeating this process until I could by a place on a very very low LVR, I'd only end up with 1 house, albeit with a good yield. Maybe I could trade my way up to a point where the net rental income on this house could be around $600 pw, but through leverage and compounding you can do far better, IMHO.

the_captain said:

Why wouldn't I use my equity to leverage into the $200K house now yielding 5%, why would I sell property one that I paid $100K for and forgo all of the capital gain and benefits of compounding.

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You would sell the $100k property because it is not NOW yielding enough. Replace the $100k property with the $200k property and leverage into another $200k property. It will not be costing you any more money to hold but will be returning an average yield of 5% rather than 3.75%.

From the way I have read your posts you are suggesting to the OP to hang onto the poor yielding property. This would, to me, seem like poor advice. That's why I called it laughable. My appologies if you can't see why your sums don't appear to add up to the best case scenario.

Why accept 3.75% as an acceptable yield when you can have 5% yield for the same cost/outlay/expense?

Gools

hi the_captain,

This is interesting, can you please clarify a few points?

the_captain said:

Loan 1 - new IO loan - total value = 280K, 280K in offset
Loan 2 - old PPOR loan - total value = 198K

So, you then pay down loan 2, so that it is retired. You do this whilst this is still your PPOR.

After you do this your situation would be as follows

Loan 1 - new IO loan - total value = 280K, 0K in offset - 100% tax deductible
Loan 2 - PPOR loan - total value = 320K, 0K in offset.

Click to expand...

Regarding what you said about taking out a new Loan1 to pay off the old Loan2, and have 100% of Loan1 (ie 280k) tax deductible... ????!!!!
i thought if the money is for private use, you wont be able to tax deduct, even though you did the loan when its a PPOR.

thanks

btc said:

i thought if the money is for private use, you wont be able to tax deduct, even though you did the loan when its a PPOR.

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I'm giving my old PPoR a few months to sell (and hopefully raise the several thousand we need to subdivide while waiting) but if it doesn't sell we'll be renting it out, not much point hanging onto a vacant house forever.

Is or is not the existing mortgage for that property tax deductable if it is rented out?

Hey RumpledElf,

I thought you would be able to do that, but now I am confused.......see this thread started by BTC

http://www.somersoft.com/forums/showthread.php?p=572468#post572468

RumpledElf,


That part of your borrowings that relate to your purchase of the property, and renovation etc costs would have tax deductible interest. On the other hnad if some of youe borrowings secured by the mortgage related to eg a car or a boat that part of the interest on your borrowings would not be txa deductible. Similarly, if say you'd put money down on the mortgage and then redrew for living expenses that part of the borrowings would not have tax deductible interest