Loan structure

[ramblin]

Hi there

I am looking for a bit of feedback on my current situation with regard to purchasing an IP.

My husband and I have a PPOR with $61k owing and available balance of $210k = total credit limit $271k

We are looking to purchase an IP between $260-300k and the bank has given us 2 options with regard to loan structure:

1. bank loan will cover IP value to 100% + stamp duty costs. No deposit required from us but they will reduce our current credit limit in our PPOR down to $185k from it's current amount of $271k. No LMI applicable as we would be reducing our PPOR mortgage limit.

OR

2. we put in 5% deposit + stamp duty. Bank covers 95% of IP + LMI is rolled into loan amount.

We don't mind covering the 5% deposit and any other costs. The main concern for us is that in option 1 the bank would be reducing our current PPOR mortgage credit limit from $271k to $185k. I feel like it is potential money being taken away from me

We aim to pay our PPOR balance of $61k off by mid 2015 so at that point we would still have a substantial amount of equity available but if we go by option 2 we would have approx $80k more equity available.

We are looking to purchase around 3 more properties over the next 10 years.

I feel maybe it's just a perception shift of not having that larger equity available but wonder if I'm missing some key financial part to making our decision?


Our bank contact said the following in summary of our options:

Scenario one may enable you not only to avoid mortgage insurance but also structure in such a way that your total loan will be tax effective . Scenario two allows you to keep the both properties separate however incur costs that can be avoided and potentially limit your full realisation of what could be tax efficient debt.

Sounds like he is encouraging option 1 which makes me suspicious

Any feedback is appreciated.

Thank you

 

[Aaron_C]

Ok. I bet the following has happened:
1. You have gotten 'pre-approval' for that new IP yet to be determined.
2. This proposal is a classic cross collateralisation for option 1. Lending you '100% + stamp duty' is false - they take security on your PPOR and IP together. There is no such thing as a 100% lend.
3. Your structure is no more tax effective than a proper non-cross collateralised one. Having big loan splits is meaningless over cross collateralised properties as having proper loan splits for separate loans/properties gives you exactly the same effect. AVOID being stitched up like this, please.

 

[Rolf Latham]

On behalf of all credit advisers, Apologies for the poor credit advice you have received.

Both are options are rubbish for you the borrower, and designed to extract maximum contribution OR maximum profit for the BANK.

The first option MAY involve cross collateralisation. I dont know if you have sufficient equity in your home to support the 300 k home loan on the home itself. Assuming this is crossed, there is little real benefit here for you, but lots for the lender. Did the banker explain the up and downsides of Cross coll ?

Do a search on the forum for same and you will see its not a well used concept in most scenarios where it can be avoided. Its very rare that one needs to use that structure



Here is an mouldie oldie, most of this still holds,and there are some more classics............. just had another this week where someone was forced into near insolvency due to poor structuring involving Cross Coll.

http://somersoft.com/forums/showpost.php?p=120656&postcount=6

Even if scenario 1 has no cross coll involved, and the IP will be free title, and the 300k odd loan is fully secured to the home is still not sensible given your stated goals, and isnt really in alignment with "best borrower lending practices".


Scenario 2 is better from the Cross coll issue..................... but I expect is still cross collateralised, since not many lenders will allow you to add LMI to the IP loan above 95 %


The most basic question to ask your credit adviser - I have a goal of another x properties in years..................

SHOW me, using your serviceability calculator and equity position models how I can achieve this.

If your credit adviser hasnt asked you those goal questions, AND shown you how to get from where you are to where you want to be, its a reasonable bet they are "transaction" focussed, rather than structure or goal oriented.

How about Scenario 3 which is kept in the "special drawer" only for staff and clients who ask ...............


Option 3A
Take a 25 % loan secured ONLY to your PPOR.

Take an 80 % lend secured ONLY to your new IP


Option 3B ( possibly more sensible if you are looking to buy again soon)
Take a 25 % loan secured to ONLY your PPOR

Take a 90 % lend ( with lmi) lend secured ONLY to your new IP

Both option 2s will require you to reduce your currenthome loan limit, 3B should allow another purchase quite soon with existing resources


New bank or a broker I suggest, your current lender has shown their cards, and has withheld material information.


Get specific advice, you have good resources, maximise their use.

ta
rolf

 

[ramblin]

Thank you both for your comments. At this stage we have preapproval to $300k and our bank guy has said we can let him know the structure we want (from the 2 options) once we find a property.

I have not heard of cross coll so will do some reading. Arrgh...hope I haven't given my kidney away.

Have to admit I didn't really explain to him our long term goal of purchasing properties, but between the attempts at up selling us on life insurance and credit cards I was beginning to not want to share anything with him. Probably not a good start.

Anyway more reading to do.

Thank you again

 

[Rolf Latham]

Have to admit I didn't really explain to him our long term goal of purchasing properties, but between the attempts at up selling us on life insurance and credit cards I was beginning to not want to share anything with him. Probably not a good start.

I guess, you know where the focus of the adviser sits then.

At its most basic, a Needs Analysis should extract your goals from you............. the risk cover stuff is important too, BUT should ideally be handled as a separate transaction as it is our business.

It is important that you find someone that you not only trust, BUT that someone should also have the courage to challenge your thought processes at the risk of "losing" the sale.

ta

rolf

 

[Aaron_C]

Just be smart about it as crossing your properties unnecessarily creates a large mess that is difficult and expensive to untie particularly when LMI and fixed rates are involved.

 

[Terry_w]

Hi there

I am looking for a bit of feedback on my current situation with regard to purchasing an IP.

My husband and I have a PPOR with $61k owing and available balance of $210k = total credit limit $271k

We are looking to purchase an IP between $260-300k and the bank has given us 2 options with regard to loan structure:

1. bank loan will cover IP value to 100% + stamp duty costs. No deposit required from us but they will reduce our current credit limit in our PPOR down to $185k from it's current amount of $271k. No LMI applicable as we would be reducing our PPOR mortgage limit.

OR

2. we put in 5% deposit + stamp duty. Bank covers 95% of IP + LMI is rolled into loan amount.

We don't mind covering the 5% deposit and any other costs. The main concern for us is that in option 1 the bank would be reducing our current PPOR mortgage credit limit from $271k to $185k. I feel like it is potential money being taken away from me

We aim to pay our PPOR balance of $61k off by mid 2015 so at that point we would still have a substantial amount of equity available but if we go by option 2 we would have approx $80k more equity available.

We are looking to purchase around 3 more properties over the next 10 years.

I feel maybe it's just a perception shift of not having that larger equity available but wonder if I'm missing some key financial part to making our decision?


Our bank contact said the following in summary of our options:

Scenario one may enable you not only to avoid mortgage insurance but also structure in such a way that your total loan will be tax effective . Scenario two allows you to keep the both properties separate however incur costs that can be avoided and potentially limit your full realisation of what could be tax efficient debt.

Sounds like he is encouraging option 1 which makes me suspicious

Any feedback is appreciated.

Thank you

Both are bad options. Avoid this bank sales person and structure it better

 

[ramblin]

Hi Terry

what would be a good structure? When you say 'structure it better', I have no idea of any other options, being that this is my first IP.

I have so far confirmed with him that option 2 means the loans are separate so it seems that is my option to go with.

Thank you

 

[Terry_w]

Hi Terry

what would be a good structure? When you say 'structure it better', I have no idea of any other options, being that this is my first IP.

I have so far confirmed with him that option 2 means the loans are separate so it seems that is my option to go with.

Thank you

U would be paying more tax with option 2.

 

[ramblin]

Can I ask for a hint on how? Do you mean with regard to not having the entire amount tax deductible such as in option A?

I don't mean to try and obtain free advice if this crossing any lines but if you could throw some key words out I am happy to go research it on my own. But when you mention other structures, I'm not sure what they might entail.

Thank you

 

[Rolf Latham]

post 3 above provides some ideas on alternative financing structures.


ta
rolf

 

[Peter_Tersteeg]

Both are bad options. Avoid this bank sales person and structure it better

Hi Terry

what would be a good structure? When you say 'structure it better', I have no idea of any other options, being that this is my first IP.

I have so far confirmed with him that option 2 means the loans are separate so it seems that is my option to go with.

Thank you

U would be paying more tax with option 2.

Can I ask for a hint on how? Do you mean with regard to not having the entire amount tax deductible such as in option A?

Option 2 has less tax deductions available because you're only borrowing 95% instead of the full purchase price plus costs (effectively about 105%).

Option 1 is not a good option because the loans are cross collateralised.

What everyone has been trying to tell you is to look at a third option where you access your equity in the first property as cash, then use that cash for the deposit and costs instead of your savings. This effectively means the properties are not crossed, but you're still borrowing the full purchase price and costs. You effectively get the best of both with none of the negatives.

This sort of structuring has been discussed substantially, but if you want to make sure it's done right, you're probably best advised to have a direct discussion with one of the resident brokers here, the advice you've had so far is not really in your favour.

In essance what you need to do is:
* Release equity from your existing property, probably by way of an investment loan soley secured against that property.
* Use the funds from that equity release as the deposit & costs for the next investment.

 

[Terry_w]

Yes, Rolf has clearly explained above. See his option 3 and 3A - either of these is the way to go I think.

Be careful when dealing with your banker!

 

[ramblin]

Thank you again everyone. I had to laugh at your comment Peter "what everyone is trying to say....." because I do feel like I am in the middle of a conversation about "who's on first"

To me the options that are presented sound exactly the same as what I have already mentioned in option 2. Therefore I am getting lost on the difference. I think it is agreed upon that option 1 from the bank is a no go, so option 2 with our 5% seems the best direction to take but the comments here are suggesting no it's not.

Here is what is confusing me. Rolf gave this option:

Option 3A
Take a 25 % loan secured ONLY to your PPOR.

Take an 80 % lend secured ONLY to your new IP

Terry then said: See his (Rolf's) option 3 and 3A - either of these is the way to go I think.

If I reduce my PPOR loan to 25% doesn't that mean I am forfeiting access to equity? At the moment my PPOR has a credit limit of $271k and a balance owing of $61k. That leaves me with $210k to access. But am I correct that reducing it to a 25% loan means if my PPOR is worth $300k then a 25% loan means reducing my credit limit to $75k, with $61k still owing so I only have $14k available to use. I must be misunderstanding what you mean by 25% loan Rolf?

If I take an 80% loan against my IP, that means I contribute 20% and doesn't that in effect reduce my taxable pool to only 80% that I have borrowed....which is what everyone is saying I should avoid.

Peter then said this:
look at a third option where you access your equity in the first property as cash, then use that cash for the deposit and costs instead of your savings.

Isn't option 2 exactly the same as above - I was going to contribute 5% and take that from my PPOR equity.

Peter also said here:
* Release equity from your existing property, probably by way of an investment loan soley secured against that property.
* Use the funds from that equity release as the deposit & costs for the next investment

Again I am confused as that is what I was going to do - take the 5% from my PPOR equity.

Maybe the key word is 'investment loan'?

I apologise I am just not getting it. I promise I am not being mentally lazy and am thinking my way through what has been said here but for some reason in my mind, what has been suggested sounds exactly like option 2 that I was going to do.

That is, buy property for $300k and take 5% from my PPOR equity to pay for it (plus solicitors costs etc). I understand everyone is saying that leaves a 5% hole on tax deductions, but then isn't that what Rolf's option 3 is about also, only in that option I was putting in 20%.

I feel terrible for taking up everyone's time with this particularly when you are all in agreement and I'm still saying HUH???

 

[Aaron_C]

ramblin - I suggest you speak to a broker like rolf and he can talk you through the process. Once you get it explained it will click.

 

[Peter_Tersteeg]

Peter then said this:
look at a third option where you access your equity in the first property as cash, then use that cash for the deposit and costs instead of your savings.

Isn't option 2 exactly the same as above - I was going to contribute 5% and take that from my PPOR equity.

Peter also said here:
* Release equity from your existing property, probably by way of an investment loan soley secured against that property.
* Use the funds from that equity release as the deposit & costs for the next investment

Again I am confused as that is what I was going to do - take the 5% from my PPOR equity.

Maybe the key word is 'investment loan'?

I may have misinterpreted your original post, I was under the impression that if you were going to use a 5% deposit it would come from savings or redraw in your existing PPOR loan. It definitely needs to come from a separate 'investment loan', although this would be secured by your PPOR.

Rolf has given you excellent advice and he is up your way. It is definitely in your interests to give him a call.

 

[Thann]

The loan purpose determines deductibility (personal use is not tax deducible)

Option 3a:

Existing loan on PPOR $61,000

NEW loan for 25% of value of new IP ( 20% deposit + 5% for costs) secured by PPOR ONLY
NEW loan for 80% of value of new IP secured by new IP ONLY

NO cash deposit, no LMI (as no loan goes over 80% of its securing property)
​

Both new loans to be setup as Interest Only (IO) to maximise deductions.

Setup Offset account, linked to PPOR loan to reduce non-deductible interest charges

Because new loans are for the purpose of purchasing an investment property, interest charged on both loans are tax deductible.

Loan used for PPOR is not deducible (If current PPOR becomes an IP in the future, then the $61k loan would become tax deductible.

If I reduce my PPOR loan to 25% doesn't that mean I am forfeiting access to equity?

No, you are using that equity to purchase an IP

 

[ramblin]

Thanks very much everyone. Think I might have to pick up some IQ points before I speak to anyone more about it.

 

[jrc77]

Ramblin,

It's not that difficult.

1. Stop talking to your bank.
2. Start talking to one of the brokers who have responded to this thread.

Regards,

Jason

 

[ramblin]

The loan purpose determines deductibility (personal use is not tax deducible)

Option 3a:

Existing loan on PPOR $61,000

NEW loan for 25% of value of new IP ( 20% deposit + 5% for costs) secured by PPOR ONLY
NEW loan for 80% of value of new IP secured by new IP ONLY

NO cash deposit, no LMI (as no loan goes over 80% of its securing property)
​

Both new loans to be setup as Interest Only (IO) to maximise deductions.

Setup Offset account, linked to PPOR loan to reduce non-deductible interest charges

Because new loans are for the purpose of purchasing an investment property, interest charged on both loans are tax deductible.

Loan used for PPOR is not deducible (If current PPOR becomes an IP in the future, then the $61k loan would become tax deductible.



No, you are using that equity to purchase an IP

Finally! I have got it now. Thank you Thann. I re-read your message a few more times and understand it now.