My first IP. Yippeeee.

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From: Peter Davidson


Thanks to all on this site for their invaluable advice, for I have purchased my first IP. Price 337K, corner block, 3 bedrooms, period features, currently leased at $250 per week, Melbourne.

I have a deposit of 65K which I will be putting towards the property.

I'm on 75K and my wife on 50K. What is the best way or options of financing this property. Currently, I am living in a property at the moment which has been in the family and not paying rent.

Do I make minimum repayments and save up for another IP or pump money into the loan, left, right and centre. Do I lock interest away for 5 years or get basic variable. Personally, I can't see rates jumping 1 or 2 % over the next 2-3 years.

Just so I can sleep at night, I want to pay principal and interest on the loan to get it down a bit.

I want to maximise my tax benefits too, so any advice would be appreciated as it has been in the past.

My wife plans to work for another 3 years before we have kids.

Thank you. It's great to be now part of the "club"!!!
 
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Reply: 1
From: The Husband


Peter

Instead of paying PI, have you considered a 100% offset account linked to an IO loan. That way you can save up for a deposit in your account or you could even save up for personal items, take the money out, the interest on your loan goes up, hence your tax deductions go up. It give you more flexibility. If you get a PI loan, your money is trapped in there (unless you have redraw). Just my opinions.

TH
 
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Reply: 1.1
From: Manny B


Hi Peter,

First of all congratulations on taking the first step... that is normally the hardest part of IP investment (getting started)...

As TH mentioned, an Offset account is the way to go (therefore any extra cash you may have can be pumped into the this account), so if u need to draw the money from the Offset account in the future to buy a PPOR OR another IP, it won't change anything in terms of tax entitlements on the property you just purchased...

Being a corner allotment (if the land size is ample), you may be able to subdivide it (build in the rear of the current property OR knock the present house down in the future to pop a couple of units/townhouses), but that's in the future... you may want to concentrate on getting a tenant in to help pay the bills (if not already done so), possibly get a depreciation schedule, etc...

Wish you all the best...

Cheers,

MannyB.
 
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Reply: 2
From: Rolf Latham


Hi Peter

If you want maximum leverage you can do this.

ANZ 95 % Loan, capitalise mortgage insurance.

Total in cost ballpark
Stamps $ 18 000
Deposit $ 17 000
Bank $ 1 000
Legals $ 2 000

Total = 38.

This leaves 27 000 for your next deal.

Use a 10 year interest only loan with Offset facility.

NEVER use more of your own money that you have paid tax on to pay for deposit and costs than you have to.

This strategy is only useful though if you want to get into your next IP ASAP, and may not be for the fainthearted. Much depends on your other peripheral things such as risk tolerance, other liabilities etc.

Seek the services of a good Indeppenent Broker and also run this type of structyre past someone that knows tax.

The structure allows you to reduce your interest liability, but still preserves tax deductability as much as possible.

Ta



Rolf
 
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Reply: 1.2
From: Rolf Latham


Hi TH

Just opinions, but in my view very useful ones.

Just on that note, while it may feel more comfortable to be running P&I and reducing the debt in some ways it can actually be more risky because it impinges on your cahs flow. Where you could have held back some cash for tough times its now buried in a loan.

Exactly the same scenario applies to higher gearing and LVRs. A higher LVR can reduce your risk of going under by allowing you to hold back cash for tough times. This is why LMI is in my opinion a cheap depreciable investment.

This may go slightly contra to accepted thinking but I have seen the results where people have been in arrears and have had to sell Ips simply due to poor risk management in terms of finance strategies.

Ta

Rolf
 
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Reply: 3
From: Peter Davidson


Hi again,

Can somebody please elaborate a little on offset accounts and how I would link that to a IO loan. Long term, what are the advantages\disadvantages and how will it help me buying my next IP in a few years time. Excuse my ignorance, I am still learning. Do the Banks advertise this? I'm currently with CBA.

Thanks.
 
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Reply: 4
From: Lotana Von Amor


Peter,

Saying that you are currently with CBA, do you mean other loans? If they are not for business and/or investment purposes than your best option is get an io loan and pay extra cash to the non-deductible loan.

Also, with most products you are not penalized for taking an io option: you can still pay extra if you wish, your interest rate is the same as for p&i loans. The bank just sets your minimum monthly repayments at a lower figure comparing to a p&i loan, that's all.

Using an off-set account is better than using a re-draw facility, because you don't have to prove that the drawn funds are used for business or investment purpose to claim interest deduction.

Lotana
 
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Reply: 4.1
From: Chris G


Hi peoples,

Congrats on the property!!

An offset account simply reduces your loan by the amount that is held in the account. So 100k loan with 10k in offset account = 90k actual loan so you pay interest on the 90k only.

You can use this account to save for you next deposit or as Rolf mentioned simply to leave some money in as a back up for any unforeseen events. If you have 10% saved for a deposit you could use 5% for the deposit and park 5% in the offset account. You end up paying the same amount of interest (effectively 90% lvr) but have easy access to the other 5% if you need it.


Cheers
Chris
 
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Reply: 5
From: Don Slade


Peter,

I have just purchased my first IP too. I did the numbers on the different products and frankly I can't see any value in an offset account. From an investment perspective it doesn't make sense. You pay higher interest and extra fees for a facility that is already available with most standard loans. Its just gimmick that gets the banks more $$$.

Offset accounts make for very very complex fee calculations. The banks are creaming it on the fees because nobody has got the time and effort to sit down and prove them wrong.

Anyway where I am leading is that a number of lenders offer very basic yet flexible loan products with very low interest rates. For example the product I went for was a 5 year interest only loan on a basic variable rate. The rate is 1/2% lower than the major lenders and there are absolutely zero fees on the account. Makes working out if bank is ripping me off easy. This loan allows me to make extra principle re-payments anytime I like at no cost - thus lowering my interest bill. Similarly I can redraw my principle payments anytime up to the original borrowing limit (90% LVR in my case). If I want to sleep safe at night I just deposit money over and above the interest into the mortgage every time I get paid. If I need extra cash I can pull it all back out again. No fuss.

Basic variable rates have been proven over time to be less expensive than fixed rates. Who is creaming it on the fixed rates - the financial markets. Banks are using fear (False Expectations Appearing Real) to promote fixed rates.

Peter - Do your numbers on what your total interest bill will be. I expect that you will find that the savings of 1/2% across your entire mortgage amount to a lot more than the interest accumulated in your offset account on your day-to-day balance.

All the best
 
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Reply: 5.1
From: The Husband


Don

I am not sure that loans with offset accounts cost anymore. I have one with ANZ bank and I think I even got the low honey moon rate. I sure it doesn't cost any more with most banks. LOCs are much more expensive though, usually half a percent or so.

You also said, "If I need extra cash I can pull it all back out again. No fuss." What about the tax deductability of this money? Eg you put $10K extra into you loan, then pull it out to go on a holiday. The extra interest on this part of the loan will not be deductable as it is not income producing. BUT if it is from an offset account, it will be because they are totally separate. You withdraw your money from the offset account, the offset amount reduces and your interest goes up. Therefore you really can have a tax deductable holiday!!

TH
 
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Reply: 5.2
From: Rolf Latham


Hi Don

Fair comment if you take rack rate products. Is < 6.00 % with a minimal fee base and offset acct is NOT expensive - or is it ?

If you have a look around you will note I made similar comments on cost issues about a week ago in a thread called LOC Calculator I think, so its not that I dont share your view to make sure that people do their sums. in this case there appears to be more of a need than the cheapest loan, like to get 95 % I/O to conserve equity you are not going to find many small lenders offering that.

Ta

Rolf
 
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Reply: 5.2.1
From: Richard Hunt


Peter,

From your comments your goals include being able to maximise your tax benefits and set yourself up for another IP some time in the future.

Looking at your current income, living situation, desire to have kids in 3 years and revert to a one-income family, I would be setting myself a goal of having 2 IP's by the time your ready to have kids, 1 fully geared in your name and the other positively geared in your wife's name to maximise the tax benefits.

Adding to some of the excellent ideas already outlined by others in the thread, to achieve this goal I'd put the following plan in action:

1.Purchase current IP in your name only
(ie to obtain maximum benefit of tax credit @48.5% due to negative gearing);

2.Borrow 95%+LMI, interest only with offset a/c (per Rolf above)
(eg. borrowing of approx $325k)

3.Deposit balance of cash in offset a/c (say $27k)
(eg. net borrowings of $298k)

4.Based on your salary income and rent income your after-tax cashflow will be approx $8,500/mth (lets exclude additional cashflow from tax credit, you'll be budgeting hard so treat yourself to nice holiday with this cash)

5.Now lets set an aggressive budget while you still can, before those kids come along and you need every cent you can get!

Budget say $2,700/mth for living expenses & property costs on the 1st IP.

The balance of your cashflow of $5,800 ($8,500 - $2,700)will fund the interest on the IP loan with the balance placed into your offset a/c.

6.At the end of 3 years your offset a/c will have a balance of $195k and your IP will be approaching a positive gearing scenario. That's your cue to do something else with the offset a/c cash!

7.At the end of year 3 buy your 2nd IP using the cash from the offset a/c as a deposit.
The 2nd IP should be positively geared and in the name of your wife to take advantage of her nil/low tax rate as a non-working mother.

Concurrently with the offset withdrawal, your 1st IP will revert to a highly negatively geared property and you can benefit from the tax savings at 48.5%.

8.I also note that you don't own the residence you are currently living in, which means you have an opportunity to use the CGT main residence exemption on your IP.

Next time it becomes vacant and while you have no kids to worry about, you might want to make it your PPOR for a short time so that the 6 year exemption rule will activate.
As the saying goes, "either use it, or lose it".

Good luck.

Cheers
Richard
 
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Reply: 5.2.1.1
From: Dale Gatherum-Goss


Hi Richard

At the risk of being argumentative . . . your strategies rely on Peter's situation staying the same. It does not allow for the negatively geared property becoming positively geared with time; nor, a change in Peter's earning capacity if he was to be made redundant; or, Peter's wife earning the bigger income with time.

I see all of the above - and more!

Be careful please.

Dale
 
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Reply: 5.2.1.1.1
From: Mark Laszczuk


Peter,
My advice to you would be to contact Dale directly to discuss an appropriate structure for you. You can rely on him, he is excellent.

Mark
'no hat, some cattle'
 
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Reply: 5.2.1.1.1.1
From: Richard Hunt


Hi Dale,

I'm always willing to accept scrutiny and have the opportunity to respond.

The strategy rightly focuses on the major changes Peter and his wife have planned for the future and delivering an outcome consistent with their goals. Nevertheless, it is also flexible enough to respond to a variety of contingencies. The ability to transfer funds out of or between the offset a/c's of the respective loans on each IP will serve to address any cashflow issues following a "showstopper" like redundancy or the necessity to adjust the gearing of the two IP's following an increase in the wife's income should she choose to return to full-time employment.

As you rightly point out, as professional advisors we bear witness on a daily basis to a plethora of unforseen events that can impact investment strategies, and owe a duty of care to clients to explore and where possible, plan for these contingencies. Nevertheless as you will understand, the unique risk profile of each client ultimately dictates the strategy implemented.

No doubt Peter's circumstances are suited to a variety of strategies, the suitability of which will vary subject to Peter's risk profile. I have provide one such strategy in response to Peter's request for various financing options and trust it will serve its purpose to help Peter and others who read the forum to identify alternatives and discuss them thoroughly with their professional advisors.

Richard
 
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Reply: 5.2.1.1.1.1.1
From: Dale Gatherum-Goss


Hi Richard

Thank you for your reply and your explanation of your thinking. I appreciate your time and trouble as I am sure do Peter and others.

Have fun, but, be careful

Dale
 
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