Mortgage trusts and serviceability

[Tyla]

Hi all

I?ve read a little bit about Mortgage Trust and how it can be used for asset protection by having second mortgage with the trust. It seems to be a good way, but it?s unclear how it will affect serviceability, and I couldn?t find any information in the forum at all.

Let?s say I have a 500k property with 100k loan with the bank. I redraw 400k to gift to the mortgage trust, then I borrow that 400k from the trust using the property as a security (as second mortgage) to repay to the bank. That way all available equity is under the mortgage trust. All good up to that point.

How can I borrow more from banks to buy more properties in the future? Will they see me as without any equity but big mortgage?

Or am I missing something?

 

[Peter_Tersteeg]

In the scenario above, you've borrowed $500k against your property. This will have an impact on your borrowing capacity, the fact that you're using the $400k to pay back the mortgage isn't going to improve your serviceability.

Using the $400k to make payments does have some interesting tax implications however. I suspect this will create more problems than it solves.

I'm also wondering if the proposed structure really does give you much asset protection. The lawyers are going to follow the money, see it's going into and out of a trust with no real purpose. Has this structure been tested in the real world?

If you're looking for asset protection, why not just buy the property via a trust in the first place? The asset protection implications have been very well tested and understood for centuries.

 

[Paul@PFI]

A sham loan through a trust doesnt give any asset protection. Its could be as evident as me taking out a second mortgage over my own home. Good luck with getting the first mortgagee to consent.

If a fixed unit trust hasd been used in this example a refinance of a change in unitholder may allow the deductible to be topped up and the funds used to payoff your own PPOR (TAX DEDUCTIBLY!)..As long as loan proceeds go to the unitholder it doesnt matter what they do with it.

ie Bank funds 80% x $400k = $320k...So an increased deductible loan of an extra $220k. Of course the $100 existing is repaid too and the loan may now sit with the trustee.

That is an asset protection strategy for the trust as you have increased the charge under the 1st mortgage.

 

[Terry_w]

Hi all

I?ve read a little bit about Mortgage Trust and how it can be used for asset protection by having second mortgage with the trust. It seems to be a good way, but it?s unclear how it will affect serviceability, and I couldn?t find any information in the forum at all.

Let?s say I have a 500k property with 100k loan with the bank. I redraw 400k to gift to the mortgage trust, then I borrow that 400k from the trust using the property as a security (as second mortgage) to repay to the bank. That way all available equity is under the mortgage trust. All good up to that point.

How can I borrow more from banks to buy more properties in the future? Will they see me as without any equity but big mortgage?

Or am I missing something?

I am a solicitor specialising in trusts and also have a credit licence and am a mortgage broker.

If you have a loan, even from a related party such as a trust you are a beneficiary of, then you would need to disclose this to the lender when you are borrowing further.

How this affects you serviceability will depend on the terms of the loan.

You also need to think of the practical implications of gifting borrowed money. If you borrow $400,000 to make a gift then the interest on this would amount to $20,000 pa. This would not be deductible. However the trust could possibly lend you back $400,000 at nil interest to park in the offset account - subject to the terms of the trust.

gifting money is serious business, especially to a trust. You may control the trust now but all control is only temporary. The money won't form part of your estate on death and your family may miss out, or some of them may miss out. Asset protection against bankruptcy may be improved but consider also asset protection upon death and upon incapacity - and even non residency. Did you know if you are absent from NSW from more than a year another beneficiary could apply to remove you as trustee?

 

[alexlee]

Tyla, why do you think you need that level of asset protection?

 

[Tyla]

Thanks a lot Peter, Paul and Terry. I read about MT in Julia Hartman's books but couldn't find info about them anywhere else. So although it sounds great especially for someone who didn't buy property in trust structure, I thought it would hurt serviceability unless there are ways to get around which I'm not yet aware of. Also as you pointed out, asset protection may be a bit questionable.

Tyla, why do you think you need that level of asset protection?

Good question, Alexlee. May be because of reading too much news and seeing people get sued for almost anything . I'm not running a business or in a profession with high risk of being sued. But I don't want to lose any of my hard earned wealth to anyone trying to make easy $ out of me. Even if it makes people think twice before thinking of suing me, I'm happy.

 

[thatbum]

Good question, Alexlee. May be because of reading too much news and seeing people get sued for almost anything . I'm not running a business or in a profession with high risk of being sued. But I don't want to lose any of my hard earned wealth to anyone trying to make easy $ out of me. Even if it makes people think twice before thinking of suing me, I'm happy.

I'm pretty sure you're more likely to be killed by a shark or struck by lightning than be sued for any large sum of money...

 

[Paul@PFI]

Thats not quite true...Some people in high risk situations can have a VERY high asset protection risk. eg a gyno, surgeon, dentist, lawyer, some accountants, some financial planners. They often have some form of professional insurance and that is the first line of defence. The common practice is to notify the insurer when the risk of a claim arises. The insurer will send the claimant to see their lawyers at no charge to commence a defence IF it arises.

I agree that many people over estimate their risks. eg assuming every tenant will sue if they trip over their own rug.

Sometimes the PI insurance may not be sufficient or the claim is outside the policy. Terry has posted the issue where say an accountant gives "legal" advice on structure or perhaps the issues is fraud etc. Perhaps the accountants or lawyer gives financial advice (ie setup a SMSF)..The insurer may refuse the claim and then the risk sits with the insured.

Common practice should be to consult legal advice early prior to asset acquisitions to ensure such risks are addressed. Contrary to many of these articles that float around on the net (they never seem to be in professional publications!!) just putting assets into a trust isnt "asset protection". A claimants lawyer will attack a flawed trust arrangement and often involve costly legal issues to defend it. So it makes sense to start with basic legal advice and to understand how to operate and NOT operate such a trust.

I have read and in practice used and advised other advisers on trust structures and the author you mention is not a person I would consider authoritative on trust law. An accountant but not a trust lawyer. A "mortgage trust" is not a structure referred to in the publications I would refer to such as this excellent Tax Institute publication. Authored 10 editions by Hardwood Andrew Lawyers. And it lacks much of the technical detail that lawyers will address...Terrys posts often mention constructive trust etc...

One of the simplest structures is not owning anything. It takes advance planning and advice on what "not" to do to harm the strategy. For others a company may assist...The very nature of the Pty Ltd" means that the propriotiery liability is limited to the amount unpaid on shares. A Directors liability may be different and a basic understanding or Corporation Act issues a first step to understanding how Directors cant always be sued.

I'm always amused by IP owners who ask about risk but own as TIC or as joint tenants for IP and even PPOR. The questions should be asked before they ink the contract.

 

[alexlee]

May be because of reading too much news and seeing people get sued for almost anything . I'm not running a business or in a profession with high risk of being sued. But I don't want to lose any of my hard earned wealth to anyone trying to make easy $ out of me. Even if it makes people think twice before thinking of suing me, I'm happy.

I'm sure you don't want to be hit by a truck either, but you still cross the road. Possibility is not the same as probability.

 

[Peter_Tersteeg]

I'm pretty sure you're more likely to be killed by a shark or struck by lightning than be sued for any large sum of money...

I haven't experienced any lightning strikes, but the odds of being sued is actually much higher than a fatal shark attack. Shark attacks are also entirely preventable as well (just don't go in the water), but there's people out there who will go after you just because they don't like you.

Still, I do agree that most people are unlikely to need really robust asset protection. Unfortunately as you become more wealthy, you also become a larger target. If your goal is to own 3-4 properties it's probably not so important. If you're building empires it's probably best to incorporate asset protection into your plans.

Also don't discount the other benefits that trusts can bring, such as tax flexibility and succession planning.

 

[Paul@PFI]

Peter touches a very good point. In some cases a trust can be problematic. eg : NSW property and loss of the land tax threshold unless its a fixed trust. Even then if the unitholders have fully used their threshold then the fixed trust is of no apparent protection and some may argue a waste of cost and effort. Units in a unit trust doesnt provide superior asset protection in any case. However, at a later date the trust could issue units to a SMSF and redeem units from an individuals (subject to reg 13.22C of SIS). So a reason to use that structure could be assocated with future super. If the trust satisfies Reg13.22C the prohibition on a SMSF acquiring residential real estate can be circumvented. I wish I had a dollar for the times I have been asked if a member can sell their IP to a SMSF.

So estate planning and asset structures etc arent always about today and the present. Sometimes other issues impact. These issues could be in 1 , 5 or 25 years. The pre-99 unit trust issue is a great example. Those trusts are now well valued 15 years after the beast was slayed. I often see clients use a trust not for any great tax savings, asset protection etc. They do so to preserve lifetime choice of who the owners of the property will be. They identify that one day the "might" want to shift beneficial ownership and avoid paying stamp duty.

Asset protection may be just one of the many issues.

 

[Terry_w]

Its rare to be sued, but if you look at the court lists there are thousands of cases each year. Bankruptcy statistics also indicate large numbers going bankrupt.

Initially you may not be in a high risk area but after you acquire and build up assets your situation may change. I couldn't have imagined that I would become a lawyer and business owner when i was younger for example.

I have a few clients who have built up several propertie between spouses with most jointly owned. they then want to start doing developments. These are pretty risky and one person at least will need to make a personal guarantee. so the risk is if the project fails they could lose half of their assets.

It is also better to set things up properly from the beginning rather than changing ownership midstream or doing these other strategies. This doesn't necessarily mean buying in trusts but chosing which names, who funds deposits and on going payments etc.

The so called mortgage trust should work from a bankruptcy point of view if it is set up properly, but rarely would this occur. People do tend to have good legal agreements in place, but then they don't follow them. No repayments are made for example - and then no action takenby the other party to recover the money.

 

[Terry_w]

Also, if there is no equity in a property because of 1st and 2nd mortgages then the trustee in bankruptcy probably won't take title to the bankrupt's share as there would be no point. But they can lodge a caveat and sit back and wait for capital growth to kick in.

They can sell the property at any stage during the bankrupty, but what is little known is that they can also get at the capital growth for up to 6 years after the bankruptcy has ended. This generally throws a spanner in the works.

 

[Tyla]

Thanks everyone for your input. You guys are great and I'm learning a lot from you all.

I know I might sound too worried about asset protection for my current situation. But I guess it's the unknown factor (or lack of good legal knowledge) that concerns me the most - what circumstances can expose me for being sued. When I hear things like people suing councils for tripping on the footpath, beaten robbers suing for injuries, people suing for harassment or defamation lawsuits, for being sick from eating at a restaurant, etc, I kind of wonder whether any person could have those litigation risks. No one will bother suing someone without any asset for injuries, negligence, defamation, etc, but people won't be that reluctant in suing someone with assets in my opinion. Also I've heard and read many times that the best time to plan for asset protection is before you acquire assets.

I've read that a lot of forum members keep properties under their personal names and they seem to be very happy with that. But some have chosen trusts for a lot of reasons including asset protection. My wife and I have a PPOR and an IP in our own names, and we're happy to acquire more in our own names for some time. Although we're currently not considering to do developments or sub-division since we're still newbies, I can't say for sure that we won't get into developments in 10 year time for example once we have more experience.

• 
  As a landlord, as an individual, how real is the risk of being sued by a tenant, a tradie, a visitor (welcome or not) to your home, a work colleague, a stranger on the street etc? How can one minimise it without sacrificing a normal life?

• 
  If we accumulate equity under own names and later decide to go into business or developments, will it be costly to structure asset protection of accumulated equity at that time?

Thanks again every one!!

 

[Peter_Tersteeg]

• 
  As a landlord, as an individual, how real is the risk of being sued by a tenant, a tradie, a visitor (welcome or not) to your home, a work colleague, a stranger on the street etc? How can one minimise it without sacrificing a normal life?

• 
  If we accumulate equity under own names and later decide to go into business or developments, will it be costly to structure asset protection of accumulated equity at that time?

Never been sued by anyone you've mentioned above. Come to think if it, I've never been sued by anyone! neither has anyone I'm close to (at least that I'm aware of). I'm also the owner of a business that deals with peoples financial well being every day.

Tyla, when was the last time someone sued you? Or even came close? Have you ever wanted to sue someone?

Moving a property in your own name to a trust is basically a transfer of ownership. You'd usually have to pay stamp duty on the current value, possibly capital gains tax, reapply for finance, etc. All those things that happen when you buy and sell property.

 

[alexlee]

As a landlord, as an individual, how real is the risk of being sued by a tenant, a tradie, a visitor (welcome or not) to your home, a work colleague, a stranger on the street etc? How can one minimise it without sacrificing a normal life?

For IP related items, there's landlords insurance which includes public liability. Getting frivolous lawsuits by a work colleague is improbable, since if anything occured in a work context, it's more likely that your employer will be sued.

If we accumulate equity under own names and later decide to go into business or developments, will it be costly to structure asset protection of accumulated equity at that time?

Yes, and here is where you're assessing probability as opposed to possibility. If you're an employee, your legal risk is lower. If you are going into business, then the risk of legal liability increases. Yes, it will be more costly to structure later on, but you also have to consider the cost of structuring now (in your example, it affects your serviceability).

 

[Terry_w]

There are basically 2 areas of risk in being sued:

1. Contractual disputes
2. Negligence

You are going to enter into various contract during your life - leases for renting yourself or leases for tenants, loan agreements, personal guarantees etc.

Negligence could arise from tenants injuring themselves, you splipping in coles etc.

It is very rare to be sued. The chances increase as you enter more contracts and do more things. With business you have more chance of getting sued because more contracts and more chances of negligence. If developing then pretty high risks. Lots of developers go under.

I have never been sued myself. But I have sued someone.

You may never be sued, but you could end up suing someone. Imagine you lend someone money, they did't pay back so you sue them. This is extremely risky. It could go to court you could win. They could appeal to a higher court, maybe the supreme court. You may be in the right but the other party could win on a technicallity. You now have lost the money, ow your lawyer his fees and their lawyer their fees.

I seen a case like this where a person bought a dud car. It went to court a few times, he was made an offer to settle, which he refused, and then he lost. End up costing him around $800,000 for a car worth $100k.

Once you have assets it is too late.
Moving assets to trusts etc reduces the asset protection strenght. A transfer is involved and this could later be attacked. Buying in a discretionary trust is stronger because you are not disposing of property.

It is also costly to transfer property. CGT, stamp duty, legals, new loans etc

 

[Terry_w]

So to reduce your level of risk, vet ever contract you enter into carefully. I admit that I boought 10 plus houses in the early days without ever readinng a contract. I entered leases without reading anything other than the rent per week. I lent money to people without written contracts.

I think very few people read contracts!

And also take care in whatever you do. If you have an investment property then fix any problem immediately you become aware of it. Especially anything potentially dangerous. Use licenced tradespersons for all installations - so if something does go wrong they will take the blame (or a large portion of it) and they have insurance.

Make sure you have relevant insurance - building and landlord for the property. But don't assume the insurance will cover you in all situations - read the insurance contract!

There is a case where a tenant tripped on freyyed carpet. Hurt her back and got $800k. Insurance probably didn't cover this because she had complained about it a few times over a long period and it wasn't fixed.

 

[Paul@PFI]

Thanks everyone for your input. You guys are great and I'm learning a lot from you all.

II've read that a lot of forum members keep properties under their personal names and they seem to be very happy with that. But some have chosen trusts for a lot of reasons including asset protection.

Its important to understand that your personal situation isnt the same as anyone else. Its dangeorous to assume - My wife always says it makes an a#$e out of you and me. Nothing beats personal advice. But the final decision is yours. You can select or discard advice. Sometimes I have given advice for the client to choose to ignore it. Thats often fine. They know their risks. Its like choosing to be uninsured. Its smart if the property is a dump and there is no debt. Its dumb if its new and there is a huge financial commitment.
- What assets do you have (higher wealth is good grounds for asset protection)
- What are your risks ? (eg a neurosurgeon v's a painter)
- Do you plan to change ownership later ? Might it even be contemplated?
- Do you want to share tax income ?
- Will a high income later bite you ?
- In 20 years might you want your super involved in property ?
- If you were to marry / remarry etc could a change of ownership give any tax benefits ?
- Are you in good health
- Is your income / occupation stable or very volatile?
- Do you have kids who may incur sexually transmitted risk ?? (The greedy GF / BF)

I wonder how many people who ask about asset protection would travel to the USA etc without travel insurance ? Or save money by replacing a light fitting themselves to save a few bucks. Or rather than fence around their IP pool while reapirs are underway they leave it open ?

As Terry just posted perhaps asset protection starts with your own behaviour. I have seen clients jump into property with their spouse to divorce months later. Or marry a douchebag loser who smashes the finances.

 

[Terry_w]

Some people have good asset protection in some ways but not other.

e.g A sets everything up very tight and fail to get their parents to property plan - with A inheriting a large sum of money and it all being exposed - perhaps for years to come.

Travel insurance is a good one. I never used to take out travel insurance until a few years ago , yet I went overseas 4 times per year. I never even considered it.