Offset / redraw / loc faq

ok so i collected a few of the recent posts about LOC redraw and offset to try and make a FAQ/sticky so people can understand it a little better, the more knowledgeable people could maybe add more information or set it out better just get a mod to post / edit it in here

i know you cant hand everything to newbies on a platter but for some of these basic but very important things can greatly help/affect the strategy of your loans
i know it would of helped me when i was first looking into this


OFFSET VS REDRAW
The offset account is better because any money you take out of it can be used for whatever purpose you want without affecting the tax deductibility of the loan.

I have a loan on my PPOR with unlimited redraw on it and also an Offset account linked to the same loan.

Is there any difference in which loan i park any extra cash ?

Both will reduce the interest on the PPOR and both allow me to access the cash when needed with no fees.

Huge difference.

The underlying question is

Will u ever turn this place into an IP.

If yes, then stop paying PI, convert to IO and place all extra cash into the attached offset account.

This will ensure max tax deductability if and when u make the current PPOR an IP.

even then it would be silly to put all your money into redraw when theres 100% offset accounts that let you take money out whenever you want
-also some redraws charge a fee to redraw money out
- the banks have control of your money when its in a redraw yet if its in an offset they have no control





LOC
Why use a LOC?

1. What are the benefits of using a LOC to pay for all the bills and maintenance of an IP? And does that make the interest you pay on your LOC account tax deductible as its expenses your paying for your investment?

The main reason is your own cash flow. You're using pre-tax equity to maintain the property without having to dip into your own post-tax savings. It should make the interest on the LOC deductible if you haven't used it for non-IP expenses (I'm not an accountant).
This also increases tax deductions and frees up cash which can pay down non deductible debt faster.

2. What does capitalizing interest mean in relation to a LOC account?
NOTE: always get advice from your accountant before attempting this!
It means you're not making the interest repayment, instead it increases the LOC balance. Be careful

3. Some people use their credit card to buy everyday things and then use their LOC to pay off their credit card. What is the reason for this? It just seems your paying debts with debts and getting deeper into debt?

If the aim is to keep tax deductibility this seems like a bad idea to me as usually a credit card is used for personal expenses? However if its just to keep you afloat the LOC interest rate is usually much less than a credit card.

Also many aim to get reward points by using a card and to get the 45 days interest free thereby leaving money in your account longer and saving more interest.

You do have to be careful when using this strategy if you will be mixing private and investment purchases on the card. If you pay it off in full every month then there would be no interest so no problem apportioning. But a credit card is also a loan, so you would be refinancing the loan with the LOC loan. If it is a split loan you should be very careful not to refinance the private portion too. There is also a tax ruling which states ATO will allow a split purpose loan to be refinanced to separate the two and they will accept this if done on a reasonable basis.

4. Does having a LOC account make work for your accountant easier as you have statements showing your incoming and outgoing funds for each IP??

maybe, but it's not much more effort maintaining a spreadsheet of expenses.


There are very limited instances where a LOC is useable without some risk of tax contamination

LOCs should (in general) be reserved for

1. Capitalizing investment debt on a Separate facility
2. Capitalize Investment expenses
3. Sometimes pull an equity loan out of a PPOR or an IP where a redraw loan is not possible


Dont use a LOC for

1. The use that most lenders promote, ie, pay your house off faster. Its admirable to want to pay your home off faster, and the products can help u do that, but you are then stuck with a tax mess if u ever turn the place into an IP

2. On an investment property using it as a savings or operating account. Every time you make a redraw for private purposes you will further contaminate the loan

3. High risk stuff where the loan may be called and you get stuck............quite a few locs have annual reviews and/ or repayable on demand clauses.


having said all that a LOC properly applied can be a GREAT tool
 
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