Capitalising Interest

[magic]

I am going to buy my first IP. I don't have a PPOR. Would I get a higher loan amount (more borrowing power/serviceability) if I capitalised the interest. Do I need a second (existing) property in order to capitalise interest or can I do it with just one property. And how? Is it by getting an IP loan with a sub-account/LOC? Or how would the structure look?

I'm looking to maximise my borrowing capacity and buy a higher priced property if possible.

If a bank/lender would lend me $300,000, how much more do you think I could borrow if I capitalised the interest instead of just the usual paying of interest on an IO loan?

And does the lender take into account that you would be capitalising interest when working out your borrowing capacity.

I'm thinking of capitalising the shortfall between rent and outgoings, or perhaps even capitalise all the interest if that helps with borrowing capacity.


Thanks

 

[Qlds007]

Think you have misunderstood the concept you will only be able to capitalise the interest within the lenders parameters i.e if the lenders maximum lvr is 90% and you initially only drew down 80% depending on the product chosen you might be able to capitalise to 90%.

 

[Peter_Tersteeg]

If you use a LOC to make the repayments, you'll run into several problems...

1. Your borrowing capacity is reduced, not increased. The LOC is an additional loan which you have to make repayments on and will be taken into account when you're applying for the next loan.

2. The LOC probably won't be tax deductible given what you're planning.

3. This strategy of affordability this early in your investing career sets off big alarm bells. In my experience it's likely to get you into significant financial trouble. Best case it will eat up your equity with no real gain, worst case it will send you broke.

This sort of strategy tends to be one employed successfully by people with years of experience, many multiples of property and millions in equity. Even then there's usually a better way.

 

[Terry_w]

I am going to buy my first IP. I don't have a PPOR. Would I get a higher loan amount (more borrowing power/serviceability) if I capitalised the interest. Do I need a second (existing) property in order to capitalise interest or can I do it with just one property. And how? Is it by getting an IP loan with a sub-account/LOC? Or how would the structure look?

I'm looking to maximise my borrowing capacity and buy a higher priced property if possible.

If a bank/lender would lend me $300,000, how much more do you think I could borrow if I capitalised the interest instead of just the usual paying of interest on an IO loan?

And does the lender take into account that you would be capitalising interest when working out your borrowing capacity.

I'm thinking of capitalising the shortfall between rent and outgoings, or perhaps even capitalise all the interest if that helps with borrowing capacity.


Thanks

You could capitalise interest by starting off with:
- Lower lvr
- lender that allows interest not to be paid each month
- or set up a LOC from which you can borrow to pay the interest.

Since you have no property you would have to use the new purchase as security. If you start with a lower LVR you are defeating the purpose - just start with a high LVR.

An alternative strategy is to borrow from a related party. Start off with a 80% loan and borrow the interest repayment from a parent (eg.). Then as equity builds up you can refiance this.

And consider the tax aspects - you are not making a tax advantage of paying off your home loan sooner so the recent ATO TR won't apply. But you could be building up cash which could be used to end up with a smaller PPOR loan. So the ATO may look at this as a scheme

- Why do you want to capitalise?

 

[magic]

I'm trying to see if capitalising interest is one of many factors which will result in a higher loan which would allow a higher priced property and hence higher chance of a higher rate of capital growth, e.g. a higher loan amount would enable me to buy a higher priced property closer to the city which historically has a higher capital growth rate.

I can afford the repayments for the loan on IO or even on P&I. So I don't need to capitalise. Being young and early on in my investing career, I'm trying to find ways where I can be more aggressive in terms of purchasing power or strategy.

But what is the point of capitalising interest when it only improves cash flow but does not improve serviceability for a more expensive property.

Is there no point in capitalising interest if I don't have a PPOR.

The only reason that I can think of is that capitalising interest would mean that I would save up the cash deposit for the next property quicker. Any other advantages/good reasons?

As Terry W says, it's better to start with a higher LVR, otherwise having a LOC of $20,000 would mean the loan gets reduced to $280,000 which means buying a smaller property, so that would defeat the purpose.

Is it possible get a loan (is it rare?) where you don't have to make repayments and let the interest build, or is that only possible with the LOC component.

Thanks

 

[Peter_Tersteeg]

Capitalising does not improve your serviceability. You capitalise interest by borrowing more money than you need, a higher loan means lower serviceability next time.

It does not improve your cashflow. As the amount owing on the loan you're using to capitalise increases, so does the interest. When that loan no longer has any funds left, your cashflow will plummet. There's two ways to increase cashflow, either earn more income or reduce your outgoings (such as reducing your loans, the opposite of capitalising interest).

A higher LVR allows you to keep more of your own cash. You can use this for a period of time to pay off the rest of the loan but it will run out. Better to keep it as a contingency fund (such as repairs or renovations), or keep it for another deposit.

In other words, capitalising interest won't give you a deposit faster. More likely it'll eat up the deposit you've already got.

There are no residential loans where you don't have to make repayments. The closest thing would be a commercial construction loan, but even that needs to be paid back when the construction is completed.

Capitalising interest is an extremely advanced technique and even then it's rarely used. It's really only used in commercial scenarios, it's definitely not for the average investor with a couple of residential properties.

 

[Vixs]

The lenders are going to lend you a maximum amount, regardless of which style of loan you go for.

You would need it to be a Line of Credit in order to have a setup where there are no repayments of any kind needed each month, as a LoC only requires interest payments to keep it under the credit limit.

Say you had a property valued at 500k and the bank will lend up to 90% on it (for the sake of an easy example).

You might choose to use a LoC of 450k to purchase the property, but in doing so you've drawn the LoC up to it's limit of 450k/90% LVR. In this case, you'd need to make repayments each month to ensure the facility stays at/under it's credit limit.

If you had used a 90% interest only loan, you'd be in the same position of needing to make minimum interest payments each month.

What you're describing, unless I've mistaken what you're saying, is a situation where you buy a property at 90% LVR using a LoC of 450k, but then at the end of the month your interest of $1,875 is added onto the 450k for a new loan balance of $451,875. While you may see the property as going steadily up in value on a consistent basis, the lenders wouldn't risk making the same assumption and automatically increase your approved credit limit on a monthly basis accordingly.

 

[Terry_w]

Is it possible get a loan (is it rare?) where you don't have to make repayments and let the interest build, or is that only possible with the LOC component.

Thanks

Yes there are a few products out there like this. However the max LVR will be 80% including capitalised interest.

So you will need to pay a higher deposit to get this sort of loan which will defeat what you are trying to achieve.