HELP - IP portfolio setup



From: Sue Storey

Hi - I'm new to this site, but very keen to get advice. My husband and I have a $110,000 house, with $32,000 equity.
We have a $28,000 deposit on an "off the plan" IP (valued $300,000) which will provide us with a 7% rent return for 5 years, to be settled in December '03 - in a high capital growth area.
We are now moving to the ACT for work reasons and so now we want to rent our current residence (ie make it an IP)and buy a home in ACT for approx. $250-$300K.
We have assets in excess of $100K (about $30K in shares, $30K in cash, $40 in general)
My husband earns $82000 and I earn $40000 gross
What is the best way to set up our finances (ie loans/mortgages/deposits etc) so that: 1.our current residence becomes an IP so the loan interest is tax deductible
2. Whether we use an i/o or a i/p loan on our new home in ACT and/or our current home
3. The best financial structure (ie.names on Titles, payment structure etc) to convince the banks to lend us the $300,000 due on our "off the plan" IP in Dec '03.
4. Our current home is in my husbands name and we have only been married for 2 months - is there anyway we can take advantage at all of the $14,000 grant to first home buyers (as in my case)
Can any guru out there help or at least direct me to where I can find these things out
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Reply: 1
From: Grant A-Y

Sue, as a newbie it is often worthwhile to use the search facility suing key words to findout if your area of interest has been discussed before (it usually has). A few days ago dee mee responded the following to someone on eligibility for the FHOG:

"Who is eligible for the Grant?

Anyone who can meet the following criteria:

The applicant is to be a natural person (ie not a company);
The applicant must be an Australian citizen or a permanent resident visa holder (at least one applicant on any application must meet this criteria);
The applicant or applicant’s spouse must not have received an earlier Grant;
The applicant or applicant’s spouse must not have previously owned residential property anywhere in Australia prior to 1 July; and
All applicants must live in the property within 12 months from the completion of the eligible transaction"

I live in Canberra. Market is pretty strong at the moment!

Grant AY
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Reply: 2
From: Mike .

Hi Sue,

I assume you have already bought the off-the-plan IP (ie signed the Contract of Sale). You say it will be settled in Dec '03. Is that a term of the contract? What happens if the IP is completed earlier than that. Will the vendor rent it out until the agreed settlement date? The reason I ask is that it may be difficult to secure a loan if you settle sooner than Dec '03.

There are two main ratios that the banks will look at when considering your borrowing capacity: LVR (Loan-to-Value Ratio) and DSR (Debt Service Ratio).

At the moment you have a "$110,000 house, with $32,000 equity." Given that the equity is $32,000, then the balance of the loan must be $78,000. Therefore, the Loan-to-Value Ratio is 70.9%. Keep in mind that Loan Mortgage Insurance (LMI) kicks in from 80%.

At this stage, your combined income enables you to cover the repayments of the proposed Canberra purchase as long as you rent the existing property. Let's look at what your LVR position would be if you purchased a $300,000 property. 20% deposit @ $60,000 plus $15,000 (5%) in costs equals $75,000. If you could raise that then you need only borrow $240,000. The total loans would be $318,000 and the total value $410,000. Your LVR is 77.6% - under 80%, so no LMI to pay.

Now you have a problem with the off-the-plan IP. How are you going to fund the deposit plus costs to keep the LVR below 80%? In 2 years time are you going to have enough equity in all three properties to cover the deposit of the off-the-plan IP?

Even if you could, my calculations show that your nett loan repayments (after total rental income is factored in) on the 3 properties is approx 31.5% of Gross Income (DSR). (Assuming loans of $78,000; $300,000 and $300,000). You may just qualify for a loan for that off-the-plan IP.

My advice:

Firstly, I think it's a dangerous strategy to buy off-the-plan without loan approval. Now that you have, play it safe and don't buy your Canberra property for more than $250,000. You can use the $32,000 of equity in your current property to fund some of the deposit.

To keep the combined LVR of the 2 properties at 80% you can borrow $210,000. Assuming 5% to cover purchasing costs like stamp duty and legals you'll need $12,500. Add $8,000 which is the shortfall on the purchase price, ie $250,000 minus $210,000 loan minus $32,000 equity. So you'll need $20,500 cash to fund the Canberra property.

You can setup the Canberra loan as Interest Only for 2 or 3 years and leave the current property as P&I with the offset account. Put all your income into the offset account and build the equity further which can be used later for the deposit on the off-the-plan IP.

Now pray that capital growth over 2 years adds to all 3 properties which can assist with financing the deposit on the off-the-plan IP. I'm assuming that you used a deposit bond here and that the deposit will be paid at settlement.

According to my calculations, if you add $30,000 of equity via capital growth then, to keep the total LVR at 80%, you can borrow up to $264,000. Furthermore, let's say that your offset account grew with savings of say $20,000, you can borrow $284,000. Based on that, you'll still have to fund the shortfall of $16,000 plus 5% costs @ $15,000.

As you can see it will be touch and go. Be prepared to sell some shares or, at worst, on-sell the off-the-plan IP.

See a tax accountant for best ownership structure to maximize tax benefits. Generally speaking, you should jointly own the properties with 99% to the higher-income earner. Bear in mind, though, that when the properties eventually go "positive" you'll have a higher taxable income, which is a disadvantage to the higher-income earner.

Good luck, Mike
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Reply: 2.1
From: Russell H

can anyone clarify the '99%/1%' joint ownership? Is it joint tenants or tenants in common? The ATO seems to say joint tenants always own 50% each - therefore half of costs and incomes. the benefit (a benefit anyway) is that on death, the property reverts to the other owner.
However, 'tenants in common' can have nominated shares - but is treated differently on death - eg, my wifes' share could go one way, mine another.

have i misunderstood? ( quite possible!)

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Reply: 2.1.1
From: Debra L


You have correctly understood the concept of Tenants in Common. When purchasing the property you nominate the percentage that each of the Tenants Common owns, for example 1%/99% and upon the death of one of them, their portion does not revert to the person (or persons) owning the other portion(s). Each of the part owners can "Will" their portion to whomever they wish.

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