Low Doc Loans and Investing

[albanga]

I have a scenario I have been thinking about and keen to explore what others think (purely an exercise, not a real life scenario):

I have no PPOR but have 350k saved in the bank.
I started my own business 4 months ago which is performing well.

I am keen to buy an IP but will only qualify for a Low Doc Loan. Given I have no equity to draw upon then I would need to use 40% of non deductible cash as a deposit.

If the property is worth say 500k then this means my deposit would need to be 200k of which would be non deductible. I am not sure how much that is per annum at current intereat rates but I imagine significant.

If the right property came along though would you still do this and then just perhaps refinance when you have a PPOR?

 

[Terry_w]

Why do you say you will qualify for a low doc? What sort of evidence of income do you have?

 

[albanga]

Why do you say you will qualify for a low doc? What sort of evidence of income do you have?

Hey Terry,
Like I metioned this is just a hypothetical so details not specific. My mind just wanders from time to time.

But for this scenario could we say that I pay myself a wage and have 4 months of payslips?

 

[Terry_w]

But for this scenario could we say that I pay myself a wage and have 4 months of payslips?

Not if you don't. Also from a borrowing point of view not if you own the company.

 

[Peter_Tersteeg]

To qualify for a lo doc loan you need to have had your ABN for at least 2 years. This is the first thing that will be checked.

They'll then look at evidence of your income. This might be BAS statements for the last 12 months, an accountants letter or trading account statements for the last 12 months.

Printing your own payslips doesn't qualify you for a loan at all.

Lo doc loans can be very difficult to qualify for...

 

[albanga]

Thanks Peter and Terry for clarifying the requirements of a low doc loan.

Looking back over my example though, say a person did qualify for a low doc, had no PPOR to draw equity from but had a 40% deposit to buy an IP. Given the loss of deductibility would it in most cases be best to wait until you qualify for full doc?

 

[Jamie M]

It depends is the answer.

You need to look at the opportunity cost of forgoing that IP and waiting until you qualify for full doc.

Cheers

Jamie

 

[Peter_Tersteeg]

Thanks Peter and Terry for clarifying the requirements of a low doc loan.

Looking back over my example though, say a person did qualify for a low doc, had no PPOR to draw equity from but had a 40% deposit to buy an IP. Given the loss of deductibility would it in most cases be best to wait until you qualify for full doc?

The type of loan (full doc or lo doc) has no bearing on tax deductibility. The only difference in the example you've given would be that with a lo doc loan you need at least 20% plus costs whilst a full doc loan only requires about 10% plus costs.

The cash you need to put into the deal (if you don't have equity) is less, so you would get more deductions.

Honestly though, all things considered the tax deductions on an IP are going to pale in comparison to what you can probably claim if you're self employed. The difference of a 10% or 20% deposit is fairly small once it trickles down to an actual refund.

We only own one IP in our own names, the rest are in trusts (trusts tend to work with being self employed). My personal tax refund last year was about $2,000. A 10% deposit difference would theoretically lead to a $200 difference. Compare this to the opportunity cost of not being able to purchase a property because I wanted to qualify for a different type of loan...

 

[Paul@PFI]

Lo Docs loans come with some risks for some taxpayers. The ATO found a very high correlation between tradies using Lo-Doc and tax fraud. So using a Loc Doc exposes taxpayers to higher risks of audit. (Cash economy)

eg Loc Doc report income as $200K and bank approves it. Actual income is $60K in tax return. Yet loan is serviced by taxpayer. ATO asks "Where did you get $ from". They then review And the will review source of the loan payments. The do a lifestyle and asset betterment review to see where your cashflows out are going. This indicates if you have unreported cash income. Its part of the role of the Cash Economy team to review these risk areas.

That said not all lo-doc borrowers are suspect. As I recall ATO found over 60% correlation to this issue at one point.

 

[Terry_w]

Thanks Peter and Terry for clarifying the requirements of a low doc loan.

Looking back over my example though, say a person did qualify for a low doc, had no PPOR to draw equity from but had a 40% deposit to buy an IP. Given the loss of deductibility would it in most cases be best to wait until you qualify for full doc?

Low doc or not would make no difference to this.

 

[Terry_w]

Lo Docs loans come with some risks for some taxpayers. The ATO found a very high correlation between tradies using Lo-Doc and tax fraud. So using a Loc Doc exposes taxpayers to higher risks of audit. (Cash economy)

eg Loc Doc report income as $200K and bank approves it. Actual income is $60K in tax return. Yet loan is serviced by taxpayer. ATO asks "Where did you get $ from". They then review And the will review source of the loan payments. The do a lifestyle and asset betterment review to see where your cashflows out are going. This indicates if you have unreported cash income. Its part of the role of the Cash Economy team to review these risk areas.

That said not all lo-doc borrowers are suspect. As I recall ATO found over 60% correlation to this issue at one point.

In some cases the borrower is signing a statutory declaration that their income is X when in fact the tax return shows inome is Y. ATO could assess the tax pay on X. I haven't seen it happen, but did read one case involving a breadshop owner.

But there is also the child support agency. I have had one client who declared $X on the low doc loan and $Y to the child support agency. They did a credit check and queried it. Client unfortunately died just after this so it didn't go anywhere, but it could have.

 

[albanga]

Thanks so much for all the detailed responses, sounds like there are a heap of considerations for low doc loans outside of the lending I had not considered.

Peter without going into great detail you talked about buying in trusts which I understand a fair few of the benefits but how do they assist with self employed with regards to low doc? For example if you didn't have the required documents for a standard loan could you buy in a trust to get around this?

 

[Terry_w]

One way a trustee purchase could assist in this situation is for you to lend the deposit and closing costs to the trust so it can get a 104% loan.

Later as equity builds up the trust refinances the loan borrowed from yourself and higher deductibility of interest is retained as well as you getting back your cash for use on the new PPOR.

Of course you, or the trustee, must factor in all the other issues relating to purchasing as a trustee - such as land tax etc.