LOC, offset account or variable loan account with redraw facility

[ximentuxue]

Hi Guys,

Just got my learner plate here Immediately, I need some valuable advice.

I bought an Unit A last year and moved in since then.

It was valued 600K and I borrowed 500K from bank A.

The 500K loan was divided as:

200K Variable with an offset account and 300K Fixed.

This month bank A helped me to revalue the unit and the now it goes up to 700K.

So I was told I could borrow 80% of this value increase which is 80K.

My options are:

1. LOC. I will be charged 0.15% higher than variable rate
2. A variable loan account with an offset account. But I have to pay $120/Y for the 2nd offset account.
3. A variable loan account with redraw facility. As far as I know, bank A doesn't charge me anything for this.

I am going to buy an investment property B the price of which is 400K. Bank B already gave me a pre-approval for 500K. My thought is that I will use 80K from bank A to pay the 20% for IP B. In that case, I only have to use my own money to pay for the stamp duty and legal cost, etc.

Considering I will buy a house and move out of Unit A (it will become an IP as well) in the next 5 years, from my research in the forum, I should go with option 2 for tax deduction purpose. Am I correct?

Thanks for any help.

XM

 

[Terry_w]

I would suggest you go with the LOC option as there are too many potential tax problems otherwise.

If your existing property is worth 700,000 then 80% of this is $560,000 less existing loan of $500,000 = $60,000. You could possibly go higher by paying LMI.

 

[ximentuxue]

Thank you, Terry

 

[Rolf Latham]

Depends on the lender

Id suggest SVR with redraw for the new equity split, unlessyour tax adviser is OK with you capitalising investment costs or interest,in which case a LOC is more suitable to task.

If you then have attach a separate Offset against the 200 variable split, you have somewhere to park your tax paid cash.

On the purchase loan, your long term goals may be better served by with a higher LVR, perhaps 88% + cap.

Dont let depreciable LMI costs get in the way of what may be a sensible borrowing decision for you.

This is especially so if you are going quite hard and have little buffer left for challenge or opportunity after the purchase

Typically, best credit advice practice suggests thatyour adviser know what the end game is, so that that they set up a structure to use the current and future resources in the best way.

ta
rolf

 

[Peter_Tersteeg]

I could argue the opposite to Terry. I've seen plenty of ways in which people use a LOC which creates tax issues.

A primary argument for a LOC as opposed to using an offset account, is that people tend to take the money from the new loan they've just set up, then deposit it in the offset account. From there they will also deposit personal funds into the offset account and may also use some of the funds for personal reasons. This contaminates the use of the money borrowed.

A better solution is to leave the money from the equity loan in the redraw facility and only use that money for investment related purposes. The offset account can be used for personal use if you wish but you'd be better off to have an offset account against non deductable debt (such as your PPOR original mortgage).

The other problem with using a redraw solution is if you pay the loan off in full, many lenders will cancel the facility, effectively making the effort of setting it up useless. There are ways around this however.

LOCs can work well for equity releases. The biggest problem (other than they cost more), is that they usually take the repayments internally to the loan account. This sounds good to the investor (using the loan to pay the bank), but the reality is that this is capitalising interest which the ATO definitely has a problem with. People also tend to have rental income go into the LOC, which also creates a problem as it's yet to be taxed and thus has the potential to further contaminate the tax deductability of the loan.

Both have their merits, but in my experience a simple interest only loan tends to be less likely to lead to trouble as long as a few rules are followed.

 

[ximentuxue]

I could argue the opposite to Terry. I've seen plenty of ways in which people use a LOC which creates tax issues.

A primary argument for a LOC as opposed to using an offset account, is that people tend to take the money from the new loan they've just set up, then deposit it in the offset account. From there they will also deposit personal funds into the offset account and may also use some of the funds for personal reasons. This contaminates the use of the money borrowed.

A better solution is to leave the money from the equity loan in the redraw facility and only use that money for investment related purposes. The offset account can be used for personal use if you wish but you'd be better off to have an offset account against non deductable debt (such as your PPOR original mortgage).

The other problem with using a redraw solution is if you pay the loan off in full, many lenders will cancel the facility, effectively making the effort of setting it up useless. There are ways around this however.

LOCs can work well for equity releases. The biggest problem (other than they cost more), is that they usually take the repayments internally to the loan account. This sounds good to the investor (using the loan to pay the bank), but the reality is that this is capitalising interest which the ATO definitely has a problem with. People also tend to have rental income go into the LOC, which also creates a problem as it's yet to be taxed and thus has the potential to further contaminate the tax deductability of the loan.

Both have their merits, but in my experience a simple interest only loan tends to be less likely to lead to trouble as long as a few rules are followed.

First of all, thank you all for your valuable advice.

I am wondering, what if I choose SVR + Offset Acc, and I take the loan (e.g. 80k) and deposit into linked offset acc. But I won't take any of it for personal use. I will just draw it all out from offset acc later for 20% of my IP deposit. And then, I will deposit just enough money into offset acc every month to pay off the interest.

Say my IP price is 400K (80k+320k), my monthly interest is $1666.67 (400k*5%/12). My monthly rental income is $1520. Annually, I have to use my own money to pay $1760 (1520*12-400k*5%) interest which my rental income doesn't cover.

Therefore, $1760 interest + $120 offset account annual fee + $3500 strata & Water & Council fee should be tax deductible at the end of financial year. Am I correct?

 

[Terry_w]

First of all, thank you all for your valuable advice.

I am wondering, what if I choose SVR + Offset Acc, and I take the loan (e.g. 80k) and deposit into linked offset acc. But I won't take any of it for personal use. I will just draw it all out from offset acc later for 20% of my IP deposit. And then, I will deposit just enough money into offset acc every month to pay off the interest.

Say my IP price is 400K (80k+320k), my monthly interest is $1666.67 (400k*5%/12). My monthly rental income is $1520. Annually, I have to use my own money to pay $1760 (1520*12-400k*5%) interest which my rental income doesn't cover.

Therefore, $1760 interest + $120 offset account annual fee + $3500 strata & Water & Council fee should be tax deductible at the end of financial year. Am I correct?

Potentially dangerous. Don't do this without a private ruling and tax advice.

 

[Aaron_C]

Potentially dangerous. Don't do this without a private ruling and tax advice.

For each time you get a cash out on a home loan? That's a pretty pricey home loan.

 

[Brady]

Potentially dangerous. Don't do this without a private ruling and tax advice.

Can you please give an example of what could potentially happen the scenario that would be an issue with the ATO?

 

[Peter_Tersteeg]

I'd leave the money from your equity in the redraw of the equity loan, don't put it in the offset. When you need to use it for a deposit, transfer it into the offset account and from there to wherever it needs to go. Make sure the amounts for the transfer into and out of the offset account are the same figure.

By putting the money from the equity into the offset account you do put yourself in a potentially dangerous situation. As you describe it, it does appear to be okay, but keeping it in the redraw is safer.

 

[Brady]

I'd leave the money from your equity in the redraw of the equity loan, don't put it in the offset. When you need to use it for a deposit, transfer it into the offset account and from there to wherever it needs to go. Make sure the amounts for the transfer into and out of the offset account are the same figure.

By putting the money from the equity into the offset account you do put yourself in a potentially dangerous situation. As you describe it, it does appear to be okay, but keeping it in the redraw is safer.

I get that it can be dangerous because you could possibly mix the purpose,

But if funds go into offset and aren't mixed, just sitting...

What is this difference in funds sitting in offset for period of time compared to put int offset then elsewhere.

Again I get the mixed purpose...

 

[Terry_w]

Can you please give an example of what could potentially happen the scenario that would be an issue with the ATO?

Yes.

1. The money is no longer borrowed money once it hits the offset account. Connection between borrowing and investing is weakened.

2. Borrowed money goes into the offset and then other non borrowed money is deposit and then investment and non investment monies are mixed. If interest could be deductible then it would have to be apportioned.

Easier to use a LOC in my opinion.

 

[Brady]

Yes.

1. The money is no longer borrowed money once it hits the offset account. Connection between borrowing and investing is weakened.

2. Borrowed money goes into the offset and then other non borrowed money is deposit and then investment and non investment monies are mixed. If interest could be deductible then it would have to be apportioned.

Easier to use a LOC in my opinion.

Do you have a link to a case where I can read about #1, where its deemed no longer borrowed once in offset.

Understand #2 very important not to mix funds.

 

[Terry_w]

Do you have a link to a case where I can read about #1, where its deemed no longer borrowed once in offset.

Understand #2 very important not to mix funds.

No cases as far as I know. Just common sense. Once the money hits the savings account it is no longer borrowed.

But, there is a pbr out there which did allow the interest deduction in such a situation. But these PBRs are private and cannot be relied upon - but are a good guide.

 

[Rolf Latham]

MISA per se is a bit of a special beast in any case Brady, remember its not your traditional transactional offset account, and probably has more chance of passing scrutiny if the offset nexus thing is to be a challenge.

ta
rolf

 

[Brady]

No cases as far as I know. Just common sense. Once the money hits the savings account it is no longer borrowed.

But, there is a pbr out there which did allow the interest deduction in such a situation. But these PBRs are private and cannot be relied upon - but are a good guide.

To me money is borrowed until its repaid. If in an offset account its not repaid.
The funds still have the same purpose and aren't mixed my common sense tells me there isn't an issue.

Would love to see something that confirms one way or another.

 

[Brady]

MISA per se is a bit of a special beast in any case Brady, remember its not your traditional transactional offset account, and probably has more chance of passing scrutiny if the offset nexus thing is to be a challenge.

ta
rolf

Talking offset of any kind not Just MISA, said I few times clear about the mixed purpose... But I struggle to see where the ATO would have an issue with funds put into an offset that isn't mixed purpose.

 

[Rolf Latham]

Talking offset of any kind not Just MISA, said I few times clear about the mixed purpose... But I struggle to see where the ATO would have an issue with funds put into an offset that isn't mixed purpose.

extension of ATO v Domjan is commonly trotted out as an offset killer by association, when the cause was perhaps more related to specific nexus issues related to mixed funds use.

I dont get too deeply into this stuff with clients, since Im not a licensed tax agent, and ask clients to obtain their own specific opinion in this and related areas.

ta
rolf

 

[n0tme]

<quote> I will just draw it all out from offset acc later for 20% of my IP deposit. </quote>
ximentuxue
Since you've planned to draw it all out, why don't you leave the new loan as is (you won't pay interest until you draw it down), then use it to buy a bank cheque for the 20% deposit for your IP (assuming the loan has redraw facility).

 

[Jolly123]

Hi Terry,

Is the money parked in LOC earn interest? I'm thinking parking an extra equity from an IP into a LOC for some months, until the next IP.

Thanks.