Loan Contamination

well the purpose was just to park the extra money borrowed into the redraw loan (IP not PPOR).

The intention was to use them for future IP purchases? I have not spent this equity release yet.
If you use it all to purchase another IP, then you should still have deductibility on all interest, but you have a problem in having mixed up funds for two different deductible purposes - IP1 and IP2.

You should have the equity release portion - i.e. the funds in excess of what was used to purchase IP1 - set up in a different loan account for IP2.

If you keep both forever, there's not a problem, but if you sell IP1, there are complications as to how much of the combined "IP1 and IP2" loan has to be paid down. No such problem if you keep the loans in separate accounts.

I think a lot of people get confused and just think of a loan as being "against" a particular property.

But the bank looks at it as "what's the asset securing the loan?" - and tends to set up loans consistent with this perspective.

The problem is that the ATO looks at it as "for what purpose were the funds borrowed?".

When you have more than one IP, these are often two entirely separate things.

You need to ensure that your accounts are set up to satisfy the ATO's requirements.
 
well the purpose was just to park the extra money borrowed into the redraw loan (IP not PPOR).

The intention was to use them for future IP purchases? I have not spent this equity release yet.

Story is:

Before refinance(1st May)

Bank: Westpac
IP1 Loan Balance: $500k
IP2 Loan Balance: $500k


After refinance (1st May)

Bank: NAB
IP1 Loan Balance: $630k
IP2 Loan Balance: $650k

All settlement excess was dumped into Offset 1 Linked to IP1 Loan: $280k

As soon this was settled, I immediately transferred
-$130k into IP1 Loan Redraw
-$150k into IP2 Loan Redraw

Which ultimately brings my Offset acct balance to $0.

Then i started putting in my salary/savings into the offset.

Mugen that's EXACTLY How NAB set it up for me! 2 months ago....
And to make it worse.. I'm in the process of moving to St george.. Everything has been approved. Valuation come up even higher... and when i asked the bank they will do exactly how NAB set up my offset.

So i wonder how many people will be in trouble by ATO if all the BANKS are setting this up by default. Anyone who doesn't work in Taxation or study taxation will have no clue what wrong and what's right. Stupid!
 
Bank should be liable to this, we're just regular person who have no knowledge of Taxation nor Accountant.

Same with the bank. They don't give tax advice but simply lend money. They don't go placing funds anywhere but ask the client where they would like the funds disbursed to.

Hard to blame the bank for this one.
 
If you keep both forever, there's not a problem, but if you sell IP1, there are complications as to how much of the combined "IP1 and IP2" loan has to be paid down. No such problem if you keep the loans in separate accounts.

That's interesting.

Say we have:

Year 1
IP1 was purchased at 500k

IP1 Main Loan : 400k

Year 2
IP1 revalued at 600k and buys IP2 at 500k

IP1 Split Loan: 100k - (Spent the full 100k for IP2's 20% deposit)
IP2 Loan: 400k

Year 3
I want to sell IP1

Will the bank allow me to sell IP1?
If the bank allows and I sell IP1 for 600k. What happens to the IP1 main loan and IP1 split loan?

And are Split loans aka LOC loans? Or different things?
 
Will the bank allow me to sell IP1?
If the bank allows and I sell IP1 for 600k. What happens to the IP1 main loan and IP1 split loan?
IP1 main loan gets paid off. IP1 needs to be securitised elsewhere in order to have IP1's title released at settlement.

But obviously if you pay down the IP1 split loan, which is really a deposit for IP2, then you lose deductibility on those funds, which is undesirable. If there's a chance you'd want to use the funds for non-deductible purposes, e.g. PPOR, your best bet is to either:

1) Transfer that $100K debt to be secured against IP2, if it's gone up enough in value to support that, or
2) See if your lender will accept a substitute security for that $100K debt, such as $100K cash on deposit, and then when you buy IP3, or IP2 has gone up enough in value to create sufficient equity, you transfer this loan to be secured against IP3 or IP2.
mugen said:
And are Split loans aka LOC loans? Or different things?
Different things.

Split loans are where you're approved for, say, $400K against a $500K property, and can "split" two loans however you want. So you can adjust the amounts of deductible and non-deductible portion. e.g. You have a PPOR worth $500K and owe $200K, and want to buy an IP. You can ask the lender to set up a "split" loan, with $200K for private purposes (PPOR), and $200K for a deposit on an IP (IP1). If you pay down your PPOR debt to $100K, you can then ask for your deductible loan to be increased to $300K without having to go through a reval or anything, because your total debt remains as $400K. But now you have $300K deductible debt, and if you're smart, set up another "split", and now have 3 loan accounts: PPOR debt $100K, IP1 deposit $200K, and $100K in your third split account for IP2 deposit.

You could - at least theoretically - have a split facility with any kind of loan.

A line of credit is a particular type of loan product that's basically like a big credit card, secured by your house. So if your house is worth $500K and it's paid off, they might give you a LOC for 80% or $400K. Then you can have a zero balance, or spend money taking up to $400K, and you pay interest on what you owe at the time, same as a credit card. You can go up to $400K, pay it all off, then go up to $400K again. They're mainly useful for people who have high turnover.

But an interest-only loan with an attached offset can basically work the same way, has lower fees, and doesn't risk compromising tax deductibility. For example,

Use $400K to buy an IP,

You pay it off in a LOC,

then redraw to buy a PPOR

> None of the interest on the LOC is deductible.

BUT

If you have a $400K I/O loan to buy an IP,

Then save $400K in your offset,

then take the $400K out of the offset to buy a PPOR,

> All of the interest on $400K remains deductible.

So not really sure why you'd ever use a LOC over an I/O loan plus offset. (Though brokers might know some good reasons.)
 
The offset's not the problem, it's combining your original purchase loan with the increased equity that you've drawn, into one loan account, that's the problem.

Think of it this way

You have 400ml of Milk and have say 10mil of orange juice. If you take out some of the milk and put it into your orange juice account, say 10ml of milk then later when you want to use your 10ml of orange juice how can you withdraw it? If you withdraw 10ml you will have 50% orange juice and 50% milk.

Have been confused by this contamination issue my entire life, and these two crystal clear posts really made my day :)

So I can safely say the bottomline is: do not mix drawn increased equity with existing loan
 
This post grew legs since I last checked!

@Terry - I really do understand the concept but the last thing I just want to clarify is in those scenarios when the banks do automatically place the top-up into an offset, what is the outcome in the following scenarios:

1 - New lender and a new offset. 50k gets placed into offset and you instantly place it into redraw. Once in redraw you leave it until required and then create a new split down the track for an IP deposit (and I appreciate why not just do this from the start but is there much of an issue doing it later?). You then use the offset as per normal. Borrowed money mever touches personal.

2 - same as above but there is personal money already in the offset so your loan becomes mixed BUT on settlement you realise this and immediately place the top up amount into redraw. Would this not be very simple for your accountant to explain to the ATO?
Using your milk/orange juice analogy it's like not shaking it up, yes it's mixed but if you poured it straight away the milk would likely come out first, albeit a hint of orangey taste :)
 
Using your milk/orange juice analogy it's like not shaking it up, yes it's mixed but if you poured it straight away the milk would likely come out first, albeit a hint of orangey taste :)

Instead of milk and orange juice what about milk and urine. If you place 20ml or urine in the milk for 1 second and then took it out - would you drink the milk?
 
What happens if the contamination was done 10years ago?

That would involve some hefty amount of money to be paid back to ATO and + the interest on them?
 
What happens if the contamination was done 10years ago?

That would involve some hefty amount of money to be paid back to ATO and + the interest on them?

Depends if it was done deliberately. Possibly the ATO would only go back 4 years unless fraud was involved.
 
Instead of milk and orange juice what about milk and urine. If you place 20ml or urine in the milk for 1 second and then took it out - would you drink the milk?

haha touche.
But putting the analogy aside for a second and going back to scenario 2, if this happens is this a big issue if you immediately move the funds into redraw.
This is the part I am having trouble with understanding, yes it has become contaminated but surely common sense prevails and you can clearly show it was an accident.

Example:
50k top up of potentially deductible debt.
Existing offset has 30k of savings of non deductible debt
Top up gets paid into offset and contaminates it.
You then however on the same day, pay it into the redraw so there is clear evidence that 50k came in and went out.

I would think surely you could show the ATO what has happened?
 
If you have a separate split of say $50k and then pay this into a savings account which also contains $50k so the savings account now has $100,000 and if you subsequently use $50k to invest then you may be able to claim 50% of the interest on the $50k - you could argue you can trace the money to the loan, but it was diluted with the cash.

But if you just paid $50k back into loan and then paid $50k from the loan, via a bank cheque maybe, then you can trace the $50k directly to borrowings so you should be able to claim all the interest on this $50k. Even though it was mixed originally you paid off this mixed loan and started again with a clean loan.
 
Interesting subject. This is what I was planning to do, but after reading all this thread I am wondering whether it is ok not.

Current setup:
Loan 1 secured against IP1

After re-financing IP1 the new setup would be:
Loan 1 secured against IP1
Loan 2 secured against IP1
Funds from Loan 2 go to Transactional Account (i.e Acc 3)

2 months later use funds from Acc 3 for deposit and costs to buy IP2, and the final setup would be:
Loan 1 secured against IP1
Loan 2 secured against IP1
Acc 3 empty (all funds used to buy IP2)
Loan 3 secured against IP2

Thanks,
Roberto.
 
Interesting subject. This is what I was planning to do, but after reading all this thread I am wondering whether it is ok not.

Current setup:
Loan 1 secured against IP1

After re-financing IP1 the new setup would be:
Loan 1 secured against IP1
Loan 2 secured against IP1
Funds from Loan 2 go to Transactional Account (i.e Acc 3)

2 months later use funds from Acc 3 for deposit and costs to buy IP2, and the final setup would be:
Loan 1 secured against IP1
Loan 2 secured against IP1
Acc 3 empty (all funds used to buy IP2)
Loan 3 secured against IP2

Thanks,
Roberto.

I would say avoid borrowing to park in the offset account. Too many things can go wrong. Only do as a last resort (I am not saying it will work either) and make sure there is no funds in that offset account other than the borrowed money.
 
What is the purpose of parking it to the transactions acc?

Isn't it better to leave in the loan 2 and pull the funds directly when you need to purchase IP2?

Because the bank ask for an account where to deposit the funds from the loan, they do not allow to leave the funds within the loan, so I need to put the funds somewhere.

I understand the concept and why funds should be left within the loan, but is it possible (i.e. do the bank allow you to do that?) ?
 
I would say avoid borrowing to park in the offset account. Too many things can go wrong. Only do as a last resort (I am not saying it will work either) and make sure there is no funds in that offset account other than the borrowed money.

Thank you. I am checking if the bank can make the funds available but leave them in the loan account.
 
Top