Debt recycling on a PPOR which could become a IP

Hi folks

Seeking some advice from the finance experts here.

Here's the situation:
Married couple, late 20s, combined gross income $175k
About to settle on a $420k PPOR at 80% LVR. No other investments.
Current cash flow enables us to comfortably put in around $800 per week more than the IO repayments.

Initially we went to a mortgage broker for the sole purpose of getting finance. This mortgage broker also happens to be a financial planner. After going through our numbers, he has very strongly suggested we commence a debt recycling strategy with the view to paying down the PPR loan as quickly as possible. Based on all of the information he has provided, it looks like a sound strategy.

However, there is a chance we will have to upgrade our PPOR in about 5-7 years (perhaps a 50/50 chance). My initial thought in going into all this was to have an IO loan on the PPOR with the view to converting it to an IP and buying a new PPOR in order to keep the debt (and potential future deductions) as high as possible. Of course, we would be pouring extra money into the offset account during this time.

I put this to the broker/adviser and he seems to think that given the uncertainty about when/if the house might become an IP, we would be better off proceeding with the debt recycling strategy. If we do decide to convert the PPOR to an IP down the track and have paid down a good chunk of the PPOR loan, we may be doing ourselves out of future deductions, however, he seems to think that the benefits from a debt recycling strategy would far outweigh whatever the value of the potential deductions would be.

Does anyone have any words of wisdom here? I am liking the idea of the debt recycling in order to take advantage of our additional cash flow during the next few years, however, there is that voice of conventional wisdom in my head saying "stick with IO if there is the slightest chance it will become an IP".

Thanks very much
 
I'm not sure what your mortgage broker is referring to as 'debt recycling strategy' as this usually involves more than one loan, ie. PPOR and IP.

It sounds like he is suggesting a 'pay down debt strategy'...??

What you have outlined sounds on the ball for your future plans. IO at 80% LVR, with all your extra cash in the offset, to maintain maximum deductible debt if/when you upgrade and convert the property into an IP.
 
ps0104 I spent the last 4 years working with various financial planners and debt recycling strategies, the concept is good, however if you pay all income into the loan and then transfer / spend what you need every drop of income is going into the loan, and then being withdrawn which basically means within 3-6years you have changed the purpose of the borrowed funds as all the money going in and out has exceed the original money borrowed. I had several bad conversations with clients when they went to rent out their PPOR and realised this.

However it is possible to achieve a similar result with interest only loans and offset accounts, basically you use the offset and build the cash in there, but it has the same net effect but as you correctly pointed out if you were to change this to an Investment property down the track would be in a much more beneficial position. I would be very mindful of anyone who advises you this strategy given you have indicated you may rent out the property they should be mindful of longer term goals and correct structure and not about the ability for them to sell some managed funds which I assume is the other part of this strategy with gearing into these as you pay down the debt. Which can still be achieved with the interest only and offset setup.

As a side note I had to switch over 300 clients loans from line of credits to offset accounts once the adviser realised this and that their Harts case ruling was maybe not as strong as they though!
 
In essence in a debt recycling strategy there's no difference in the outcome if you put the money into an offset account against the PPOR loan, or if you make the extra repayments onto that loan. The outcome is the same.

The real difference will be in the flexibility of your money later on if the property becomes and IP.
 
This needs careful taxation planning and advice which a planner may not be capable of.

The debt recylcing works like this;

$500,000 property, $400,000 loan.
You plough all your spare cash into the loan, get it down and then reborrow the available equity. This should be done using a separate loan (and this is what most don't tell you about).

So you could use an offset account and then once the balance is up to say $50,000 you pay $50,000 off the PPOR loan and then set up a new loan for $50,000 which will be invested:
$350,000 loan - interest not deductible as used for PPOR
$50,000 loan - interest deductible because used for investment

The $50,000 is borrowed at say 5% and invested in high yielding shares which may return 8%, so you are making around 3% (for example) or $1500 per year.

This $1500 in income is used to pay down your $350,000 loan even faster. And then you reborrow again - another $50k may produce $3,000 in income now.

This speeds up as compounding kicks in.

It won't really work as fast if you do not pay down the PPOR loan. But it could still be done. When you eventually move out the PPOR loan may be down to say $250,000 and the investment loan may be up to $150,000.

However you are right in that once you move out you will only be able to deduct the interest on the $250,000. But you may have investments worth say $250,000 which a loan of $150,000 was used to purchase. You could then sell these and pay CGT and be left with some money which could be used to pay the deposit for the new PPOR.

Your fin planner should be able to do some forcasting for this sort of thing. Make sure he or she fully understands the deductibility of interest and potential issues.
 
Thanks for your helpful responses.

TerryW - the strategy you have outlined is exactly what has been recommended. The adviser has indicated a separate loan would be required.

So, what you are saying (please correct me if I'm wrong) is that while a debt recycling strategy can be done without paying off the PPOR, the benefits would be reduced?

Cheers
 
Thanks for your helpful responses.

TerryW - the strategy you have outlined is exactly what has been recommended. The adviser has indicated a separate loan would be required.

So, what you are saying (please correct me if I'm wrong) is that while a debt recycling strategy can be done without paying off the PPOR, the benefits would be reduced?

Cheers

It can't be done to the same extent without paying down the loan. This is because you would be using cash to invest (offset funds) instead of borrowing to invest. Initial tax treatment would be worse as you are increasing the non deductible interest you pay. You also get less compounding as you are investing less.
 
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