From: Firefrog .

This is somewhat of a newbie question, but I have to know.
How is equity used when buying IP's? Does your original loan (eg.on own home) increase after you access the equity? What are the mechanics of using equity. How does it happen.

The Frog


You can achieve far more than you allow yourself to believe. - David Pollitt
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Reply: 1
From: Mike .

Hi Firefrog,

Here is one way that you can do it:

Miss Jackie Davis owns her own residence (that she's been paying off for a number of years) and wants to purchase an investment property but doesn't have enough cash for a down payment.

Her owner occupied residence is valued at $270,000 and she has an outstanding mortgage of $165,000 (she's financed through an XYZ bank Standard Variable Rate home loan at 7.15%). Her current monthly repayment is $1,182 (totalling $14,184 each year).

The property she wants to purchase is being sold for $200,000. By refinancing her owner occupied residence with an Equity Alternative for $205,000 she'll have an extra $40,000 (after the refinance) to apply to the purchase of her investment property.

Jackie then takes a second loan for $160,000 to purchase her investment property and applies $40,000 from her refinance to complete the purchase. Her second loan will have a monthly repayment of $1,191, and she will have a rental income to offset this amount.

Me again: In the above example, Jackie Davis has consolidated the IP deposit loan with her Home Loan, and the IP is self-secured. Alternatively, you keep the $40,000 as a separate loan via a Line Of Credit and still avoid cross-collateralization (ie the IP is self-secured).

The third option is to take out a 105% loan to cover the entire purchase price of the IP plus purchase costs but use your home as part security. The advantage of this option is you can have the entire loan as Interest Only and fix the interest for 3,5 or 10 years. Whereas you have to make principal and interest repayments on the first option and while you don't have to pay down the LOC straight away, the rate is usually Variable.

Remember, Miss Jackie Davis could do this because she had $105,000 of spare equity. Which is the difference between her residence valued at $270,000 and the outstanding mortgage of $165,000.

Regards, Mike
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Reply: 1.1
From: Nic Hutty

In the long term which strategy do you think is best Option 1,2 or 3? Does casflow influence your decision?
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Reply: 1.1.1
From: Mike .

Hi Nic,

Sorry for the late reply, just had to make some enquiries.

Here are the 3 options:

I have a home mortgage with sufficient equity to purchase an investment property. Should I:
1. Apply for 105% loan and use equity in home for 20% deposit?
2. Apply for separate LOC to cover 20% deposit?
3. Refinance Home loan so that balance of home loan increases by IP deposit amount?
What are the pros and cons of each option?

My thoughts:

My understanding of the 3 options are:

Option 1 allows you to pay interest only on 105% loan thereby improving cashflow and perhaps loan capacity.

Option 2 requires 2 loans which can be effectively interest only since only the interest liability of the LOC need be met. With this scenario, the investment property is self-secured, unlike the first option where the IP is cross-collateralized.

Option 3 is difficult to separate the interest earned on IP deposit amount and is not interest only.

Are there any other considerations with any option that I have missed?

Enquiry 1:


Option 3 is not a good option as you have already concluded.
You could apportion the interest on the extended home loan but the real problem is that a portion of the investment loan would be P & I reducing - while you have any non tax deductible debt you should be interest only on all tax deductible debt.

Option 2 is OK if you don't want cross collateralisation of loans. In practice cross collateralisation is not normally a problem. If you adopted this approach you could do better than a LOC.

Option 1 is the best purely from a financial point of view. I would recommend a full offset account on the home loan with rental income, as well as your other income, all going straight into the offset account and therefore effectively coming immediately off the principal of the loan on a daily basis.

My reply:


What you said clarifies most of those points for me except what you said about Option 2. I'm not sure what you mean when you say "In practice cross collateralisation is not normally a problem. If you adopted this approach you could do better than a LOC."

How can you do better than a LOC for the deposit if you want to avoid cross-collateralisation? The reason I see cross-collateralisation as a problem is that it gives the lender too much power over you when you are seeking future loans. If your existing properties are all tied together with the one lender those properties can be valued down so your leverage is reduced, and it would be difficult to refinance all the loans with another lender.

Is that the main problem with cross-collateralisation or have I missed something?


If you raise a LOC on your home you still have the same amount of debt as if you cross collateralise - so your financial position is no better.
If a valuation were to come in lower than expected, there's no guarantee that any other lender will come up with a better valuation. Lenders don't come up with the value - a registered valuer does - lenders don't try to get valuations down.
It isn't necessarily difficult to refinance - but you wouldn't do it unless there was a better deal.
My comment about doing better than a LOC is that you could raise a normal loan for the deposit, rather than a LOC, and get a better interest rate.

Enquiry 2:

Hi Micheal. The 105% option is a genuine stand alone offer. Not like certain other lenders who sheepishly advertise a 105% lend and then tell you have to supply another security to cross collateralise!

This deal is only for prime property in top locations and for high income earners and you pay a premium, and so this option may not be suitable.
But lets call this a fourth option.

With LOC's you can do splits and cocktails so the options are limited only by your requirements. [part fixed, part variable, part LOC, with no, one or two credit card facilities, and up to ten separate accounts, etc]

Me again:

Summing up, Option 1 and 2 are the main choices. Loan consolidation re Option 3 usually applies to purchases like cars, boats, weddings etc where consolidating is better than a separate personal loan.

Option 1 is more cost effective (therefore better for cashflow) than Option 2 which is more flexible but you pay for that flexibility.

Regards, Mike
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From: Rolf Latham

Hi all

Or, get an independent broker to demonstrate the $ differences between the various types of structures. Pictures and diagrams tell the story much more easily.


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From: Victor Mann

in relation to offset v loc . It used to be that lines of credit were more expensive than offset accounts IE interest rates and charges. However many are now the same as offset accounts or very close in rates of interest. Charges are slightly higher per year. But both offset and loc work in the same way in that your balance that you pay interest on reduces as soon as u place money into an account. BUT offset accounts only allow you to withdraw amounts over and above your monthly required payments. Loc however allows you to withdraw all the money back up to the limit if you wish. It all depends on what you want to do over the next 3-5 years.

Hope this helps....email if you need further info

Good hunting..........

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From: Les .

G'day all,

Probably the major difference between LOC and Offset is that LOC is a "credit" account, while Offset is a "Debit" account.

In other words, LOC is possibly more "dangerous" for those who have a tendency to splurge on credit. With Offset, it is (usually, but not always) your own money that you are taking out of it.

That could possibly assist those who are deciding "which kind to use".


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