Debt recycling & living of equity through a LOC from a lenders perspective

[Peter_Tersteeg]

There is a common belief out there that people can use funds from a line of credit to either recycle non-deductable debt into deductable debt, or even to 'live of equity'. In some cases people even have the perception that a line of credit is a loan which is not secured by a particular property.

I'm not going to debate the tax deductablility of the line of credit in these strategies, both debt recycling and living of equity strategies imply that the borrower is not paying the interest on these facilities out of their own income. These strategies imply that interest is simply drawn periodically until the limit on the loan facility is reached.

This afternoon the CBA sent an email to brokers which has a different opinion...

Line of Credit Accounts without payments
As you may be aware the Bank regularly conducts reviews of Line of Credit (LOC) accounts to ensure customers are enjoying all the benefits of the product. In a recent review, the Bank identified a number of LOC accounts where the customer has not made a payment for more than three months.

What's happening
From Wednesday 4 May 2011, the Bank is writing to Line of Credit (LOC) customers who have not made a payment to their account for more than three months.

What you need to know
• While there are no contracted minimum repayments for LOC accounts, customers must at least make a payment to cover monthly interest, fees and charges.
• Depending on the customers utilisation of their credit limit the letter either recommends, or requests, that they arrange regular monthly payments to their LOC account to cover monthly interest, fees and charges.
• These letters will now be sent to relevant customers every month (a single customer will be contacted no more often than every 3 months).

What you need to do
• If you receive customer enquiries about these letter(s), reiterate the importance of making regular payments to their LOC account to meet monthly interest, fees and charges.
• Discuss the various payment options available (e.g. salary credits, NetBank Scheduled Transfer, Automated Funds Transfer etc) and assist them to make these payment arrangements.

Want to know more?
The Consumer Mortgage Lending Products Terms and Conditions state in clause O3.1/LOC3.1 on page 70 that:
"Unless we agree otherwise, each calendar month you must deposit to your account amounts equal to or greater than the total of any interest, fees and charges debited to your Loan Account during the previous month, or otherwise when we demand it."

Essentially the CBA's policy is summed up in the last paragraph. Banks expect reglar repayments into a LOC facility and the CBA is now making regular reviews of these facilities. I expect that the first thing the CBA would do if there were multiple breaches is they would withdraw the remaining limit. This could cause substantial financial stress to some borrowers.

There are valid ASIC approved ways to recycle debt that are not in breach of lender policy and are fully tax deductable without requiring an ATO private ruling, but it does require the right structure and strategy. Feel free to get in touch if you'd like details on how this can be done.

 

[Token Funder]

There is a common belief out there that people can use funds from a line of credit to either recycle non-deductable debt into deductable debt, or even to 'live of equity'. In some cases people even have the perception that a line of credit is a loan which is not secured by a particular property.

I'm not going to debate the tax deductablility of the line of credit in these strategies, both debt recycling and living of equity strategies imply that the borrower is not paying the interest on these facilities out of their own income. These strategies imply that interest is simply drawn periodically until the limit on the loan facility is reached.

This afternoon the CBA sent an email to brokers which has a different opinion...



Essentially the CBA's policy is summed up in the last paragraph. Banks expect reglar repayments into a LOC facility and the CBA is now making regular reviews of these facilities. I expect that the first thing the CBA would do if there were multiple breaches is they would withdraw the remaining limit. This could cause substantial financial stress to some borrowers.

There are valid ASIC approved ways to recycle debt that are not in breach of lender policy and are fully tax deductable without requiring an ATO private ruling, but it does require the right structure and strategy. Feel free to get in touch if you'd like details on how this can be done.

As I have been saying for a long time, LOE is a strategy predicated on the notion the a bank will be happy for you to live on debt you don't intend to repay. As a general proposition, we ain't.

It is therefore not so much a strategy a hope.

Living on rent on the other hand makes sense, which is why yield matters.

 

[Propertunity]

Living on rent on the other hand makes sense, which is why yield matters.

Yes, until an individual borrower becomes too "rent reliant"

 

[jaycee]

Yes, until an individual borrower becomes too "rent reliant"

Doesn't Living on Rent imply a cashflow positive portfolio giving you cash to live on ?

How does the bank stop you from receiving the cash and living off the rent by deeming you to be "too rent reliant" ?

 

[Propertunity]

Doesn't Living on Rent imply a cashflow positive portfolio giving you cash to live on ?

Yes

How does the bank stop you from receiving the cash and living off the rent by deeming you to be "too rent reliant" ?

I should have explained further, sorry. They (obviously) can't stop you from receiving rent. But I was referring to the Mr Funder types, of bizzaro world, where they live wrapped up warm in their cardigans, who won't extend further credit to borrowers for the purpose of buying more IP's because they don't have a 'proper job'. but instead rely on rents.

 

[RealBus]

Unless the bank requires you to prove ongoing affordability there's nothing stopping the LOC to be withdrawn and the funds used to payback the loan as contractually required.
If they were serious about regulating this product which their not they would request periodic assessment of servicability. With that in mind there's new mtg product such as reverse mtg's etc seriously!

 

[jaycee]

Yes

I should have explained further, sorry. They (obviously) can't stop you from receiving rent. But I was referring to the Mr Funder types, of bizzaro world, where they live wrapped up warm in their cardigans, who won't extend further credit to borrowers for the purpose of buying more IP's because they don't have a 'proper job'. but instead rely on rents.

I know, Living on Equity however also sees the same sort of isse I thoguht from reading here (I actually live on peanuts), so same brick wall coudl be hit with both strategies.

 

[Bigtone]

Unless the bank requires you to prove ongoing affordability there's nothing stopping the LOC to be withdrawn and the funds used to payback the loan as contractually required.
If they were serious about regulating this product which their not they would request periodic assessment of servicability. With that in mind there's new mtg product such as reverse mtg's etc seriously!

exactly all it needs is two extra transactions

line of credit to savings account $2k or whatever

savings account to loc account $2k, same result achieved

many of those LOC have been sold by the banks and in their documentation on the basis that no payments are required if under limit so imposing the requirement which is easily overcome is just a waste of time

i don't think it would effect live on equity or debt recycling in any way. whether they are legitimate option however is a very different discussion all together

 

[Rolf Latham]

CBA Viridian is an odd animal in any case.

Its a non capitalising, capitalising LOC : )

If you stick with lenders whose LOC does nor require an interest repayment until meeting the limit you will have a better chance of survival.

Part of the problem with the Viridian is that its SOLD as a "proper" evergreen revolver, and it isnt .

ta
rolf

 

[Terryw]

exactly all it needs is two extra transactions

line of credit to savings account $2k or whatever

savings account to loc account $2k, same result achieved

many of those LOC have been sold by the banks and in their documentation on the basis that no payments are required if under limit so imposing the requirement which is easily overcome is just a waste of time

i don't think it would effect live on equity or debt recycling in any way. whether they are legitimate option however is a very different discussion all together

That is what I was thinking, but this will adversly effect the tax deductibility of the loan and it would be messy to calculate.

Maybe a better way would be to have 2 LOCs (ideally at separate banks) and borrow from one to pay the other??