Can you use your equity to service your investment loans?

[agent007]

Hi James,

It's not what you expect to happen - it's what your lender views as a risk . The lender wants to minimise it's risks (remember you're paying the same rate as a low risk OO).

Well, these are the type of things one shouldn't tell the Bank. As you well pointed out, they expect you to use those funds to support other areas of the economy

The banks expects (rightly so IMO) that a borrower will spend the LOC on plasma & O/S holidays & put repayments as a lower priority. I came across a good quote recently - Think how stupid the average person is and remember that half of then are stupider than than.
Cheers Keith

I coudn't agree more

 

[s_t]

Think how stupid the average person is and remember that half of them are stupider than that.
...........
Cheers Keith

That should be 'think how stupid the median person is and remember that half of them are stupider than that'

 

[cletus]

Its a completely valid strategy to use equity to service debt. In fact you'll find people use this ("debt recycling") to replace a non-tax deductible home loan (owner occupier) with tax deductible debt.

For example: you own a $1m property with a $300k mortgage thanks to property growth. Draw down $500k to buy another investment property. Your LVR on your home is now 80%.

With the $500k, put a $250k deposit down on a $1m property (or portfolio of properties) with a rental yield of 5% and an LVR of 75%. You've borrowed an additional $750k (all at 9% for argument's sake) for a total debt of $1.25m. (excluding your $300k home loan).

It takes $112.5k per year to service that debt. Your property/portfolio yieelds $50k per year for a shortfall of $62.5k. Even at a 40% tax bracket, thats a deduction worth at least $25k per year to you.

You take that $50k and use it to pay off your home loan. The remaining $250k from your original drawdown is used to service the investment debt. You can balance these numbers as a function of rental yield, interest rates, etc. The idea is to get the right LVRs such that by the time the equity used to service the debt is gone you've repaid your owner occupied loan and then you can use the money you were using for that to service the investment loans. Hopefully by then (in ~5 years) the rental yield is also higher.

What are you left with? A $500k loan on your home thats fully tax deductible (hence the term "debt recycling").

Of course you need to consider transaction fees and its still important to buy the right property.

Assuming property growth of 10% then after 5 years your $1m investment has appreciated about $600k, your home loan is tax deductible and the rental growth will have (hopefully) increased to the point where it covers or almost covers the $750k loan.

This strategy works best is a rapidly rising market because its highly leveraged.

Anyway, don't take this as advice.

 

[Token Funder]

I've never thought I was spending anything other than borrowed money.

But let me ask you;

Is there really any difference between me spending $50k of money I've been saving into an offset account from my day job on my holiday versus me borrowing $50k against a property that has experienced $100k growth?

I mean, money is money, right? The cost the same, 8% or so.

I think it's the same. Debt = cash flow = capital. It spends the same and costs the same. Just need to spend less than you 'earn'.

Ummmm...one is your money....the other is borrowed from someone else with an obligation to repay under a contract the provides all the rights to the entity you borrowed from including a right to alter pretty well any of the terms on 30 days notice

If you don't see the risk differential between the former and the latter, I'm not sure I can help

 

[Land]

I still think DavidMC is right. Either you spend your own 50K for a holiday and forgo the 8% interest you could make on it in an online savings account for example, or you use 50K of debt for a holiday and pay the 8% interest costs.

Yes, I do have to agree that there is a greater risk in borrowing the money, rather than the lost opportunity cost of making 8% on your own 50K, but provided one is sensible about it, it shouldn't be a problem.

It's all relative i.e. spending 50K on holiday when your portfolio is worth 10M with an LVR of 40% is very low risk vs. spending 50K on a holiday when your portfolio is 500K with an LVR of 80% is a lot more risky.

Capitalising interest is an excellent strategy provided it is used properly and with correct risk management strategies in place.

Hell - people use LOCs all the time to buy a flash boat etc, so I applaude people who actually use it to further their investing!

Ummmm...one is your money....the other is borrowed from someone else with an obligation to repay under a contract the provides all the rights to the entity you borrowed from including a right to alter pretty well any of the terms on 30 days notice

If you don't see the risk differential between the former and the latter, I'm not sure I can help