Reducing home mortgage using cashflow from negatively geared IPs?

S

surm

Hello,

We had discussions with two property investment companies (Merlot and Park Trent) because both of them got our attention by saying there is a way to pay off our home mortgage quicker using IPs. Their concept was that negatively IPs generate cashflows that can be circulated through investors’ home mortgage’s offset account.

This is one of their main selling points in the initial telemarketer’s call and the second 90 minute presentation (Park Trent) / in house discussion (Merlot). In my opinion, ParkTrent and Merlot misinform the potential clients.

They say that the tax returns for negatively geared properties can be arranged to receive with the pay (weekly, fortnightly etc, which is true) and combining this with rental income, there is a cash flow that is pumped to the offset account of the home mortgage (home that the investors live in) before getting it back from at the end of the month to pay for the mortgage premium of the IPs.

This does not make sense at all to me. In fact, I have asked both Merlot and Part Trent representatives about this who were adamant that this was the ‘secret’ behind paying off the home mortgage quicker. On the contrary, my calculation is that the cash flow of a negatively geared property (rent + tax refund because of the negative gearing + tax refunds for depreciation) is always lower than the mortgage premium of the IP, therefore, there is no accruing benefit that would speed up the paying off of the home mortgage the investors live in.

If anything, the only benefit is that the investor gets is the rent at the beginning of the month, but pays the mortgage of the IP at the end of the month, so the rent can be held in the offset account of the home mortgage. The effect is equivalent to paying a one-off payment to the home mortgage to the value of the rent generated from the IP.

Have I got this wrong? Are Merlot and Park Trent correct?

Thanks
 
From my experience this is the same methodology most commonly used by these type of companies when explaning the "sales pitch" and they are correct in a way.

Your PPOR will usually be on a P&I loan with an offset while your IP/s will be on IO loans. Your repayments for the PPOR are primarily determined by the interest component of the P&I loan.

So by putting all your income (wage, rents, tax deduction on PAYE, etc) into the offset account for the PPOR loan then once a month paying the IP loans and your standard PPOR payment you actually receive the benefit for that month by reducing the interest incured for the interest component of your P&I loan therefore you really pay more than required therefore pay it off more quickly.

Its the componding effect of doing this monthly that continuly saves you the money off your PPOR loan which is non-deductible debt while leaving the full interest amounts owed against the IP at the maximum levels but this is a deductible debt so is more beneficial.

I may have confused you more but hopefully it maybe of some help.
 
womble66 said:
So by putting all your income (wage, rents, tax deduction on PAYE, etc) into the offset account for the PPOR loan then once a month paying the IP loans and your standard PPOR payment you actually receive the benefit for that month by reducing the interest incured for the interest component of your P&I loan therefore you really pay more than required therefore pay it off more quickly.

Its the componding effect of doing this monthly that continuly saves you the money off your PPOR loan which is non-deductible debt while leaving the full interest amounts owed against the IP at the maximum levels but this is a deductible debt so is more beneficial.
Click to expand...

womble66, thanks for the response.

I understand that directing the rent and tax deductions to the offset account of the PPOR reduces the interest. But how much? Isn't this equal to doing a one-off payment to the PPOR mortgage ie no compounding effect?

Here is an example to show what I think:

All my other current earnings (mainly salaries) already go to the offset account of the PPOR.

Now, I am going to buy an IP to pay off the PPOR mortgage quicker by circulating rent + tax deductions through PPOR mortgage.

For the IP:
Suppose rent + tax deductions = $2,000 a month
Suppose the mortgage premium = $2000 a month (for the sake of clarity, let us assume so)

So,
  • On each 1st day of a month, I get $2,000 (which goes to the offset account of the PPOR)
  • On each last day of a month, I withdraw $2,000 from the PPOR offset account and deposit in the IP account

So, what is the effect? The effect is equivalent to permanently keeping $2,000 in my PPOR offset, in other words, making a one-off payment of $2,000 to PPOR mortgage.

Because at the end of the month, I will have to withdraw $2,000 from PPOR offset account to pay for the IP, there is no compounding / accumulating effect as long as the rent + tax deductions are below the mortgage premium (ie. negatively geared).

So, in reality, for a negatively geared IP, mortgage premium costs more than the rent + tax deductions. So, to make up the shortfall, I have to take extra money out of the PPOR offset, which prolongs the life of the PPOR mortgage rather than shortening it as claimed by those two companies.

Could someone kindly tell me whether my calculations are wrong or whether I have missed something?
 
Putting all your money into the offset account then paying the bills is the right way to do this. As you've indicated, this will prolong the PPOR mortgage because you're in a negative gearing situation.

There's not much you can do about this, becuase negative gearing does tend to have a negative impact on your cashflow, which reduces your ability to pay off non-deductable debt.

You could look at a stategy where you also invest in other positive geared assets to offset the negative gearing from the property.

I also think that your assumption of $2000/mth income (even after gearing) against a mortgage costing you $2000/mth is optimistic. Unless you've found an incredible cashflow deal I expect you'll have a substantial shortfall.
 
PT_Bear said:
I also think that your assumption of $2000/mth income (even after gearing) against a mortgage costing you $2000/mth is optimistic. Unless you've found an incredible cashflow deal I expect you'll have a substantial shortfall.
Click to expand...

I agree 100%.

I took the matching numbers to show that even in this optimistic favourable case, this set up does not help paying off PPOR mortgage any quicker (contrary to what is claimed by Park Trent and Merlot).

In a realistic situation where there is a shortfall, the funds to meet the short fall are taken out from the PPOR offset account, which lengthens the time to repay the PPOR mortgage. This is what I think. So, I can't understand what calculations or strategies companies like Park Trent or Merlot employ to achieve the opposite.

I understand that, superficially, their story sounds plausible. They say that circulating the cash flow generated from a negatively geared IP through the PPOR mortgage offset account reduces the interest of the PPOR. So, by having multiple IPs, you get multiple rents and tax offsets, all of which is credited to the PPOR offset which in turn reduces the PPOR interest even quicker.

But, as seen above, the numbers say the opposite is true.
 
even if it true it is not a good enough reason to buy anyway, the costs (both real and opportunity) of buying a dud property far outweigh the benefits.

the tax and home mortgage reduction should be a side benefit not the main purpose.

even a gun block of land with no tax benefits or rental income can be a better asset if it appreciates enough in value

i have said it before if anyone wants to buy one of these crap type of marketed properties just let me know i can get a $30k kickback and we can go halves.

why would they pay a $30k kickback? think about that b4 you sign ur name on anything
 
debt recycling is the term to search on. The shortfall between interest payments and rent is actually borrowed, or increases the investment loan, while the other income is left in the PPOR offset, reducing the PPOR loan. Taking it a step further the full costs of the investment are capitalised, and all income, both rent and earned is used to pay off the PPOR sooner.

Get tax advice on this, but it means you are 'recycling' your PPOR debt into investment debt. Once this is completed, there is more cashflow able to be used to finalise the remaining Investment loans, because the repayments can be made before tax.
 
tobe said:
debt recycling is the term to search on. The shortfall between interest payments and rent is actually borrowed, or increases the investment loan, while the other income is left in the PPOR offset, reducing the PPOR loan. Taking it a step further the full costs of the investment are capitalised, and all income, both rent and earned is used to pay off the PPOR sooner.

Get tax advice on this, but it means you are 'recycling' your PPOR debt into investment debt. Once this is completed, there is more cashflow able to be used to finalise the remaining Investment loans, because the repayments can be made before tax.
Click to expand...

good strategy but u also want the asset to be good as well whcih won't happen of a marketeer
 
surm said:
Is it a joke or do you actually deal with those mobs?
Click to expand...

its not a joke, these marketing companies will usually offer a $10-$15k kickback.

they are normally working for a developer and if u find out who that is they will pay 5-6% of sale price because thats what they pay the marketing companies.

do u know what the marketing companies pay the telemarketing companies for a qualified lead? $1200, they think they can convert 1 in 3 and total cost per sale is $10k so with $30k commission they r making $20k per sale.

i have always talked people out of buying this crap so have never received a payment from marketeer

however a couple of times people have really wanted to buy something off the plan before it started (not through marketing companies) and i have approached developer and got a payment, had a guy from china (FIRB) wanting to buy an apartment in st kilda road, was going to buy no matter what, apartment was $650k, 6% kickback = $39k, $19.5k each. they won't drop price because it will effect valuations on others but they will pay a rebate if u ask the right people, they want them sold so they can get the finance to start building.
 
Ok, I don't want to make this more painful than is needed for those of you who are all over this, but I have a similar question:

1.
which prolongs the life of the PPOR mortgage rather than shortening it
Click to expand...
I think I agree here. Essentially you are adding for eg. $2k in rent, then taking out $2100 to make up the shortfall, then adding $2k in rent and so on. Over time, it will have been better off to just keep putting the $100 into the offset which would eventually exceed the $2k going in.

However, isn't part of the point to be able to hold a large asset for small amount of your own cash?

Question: Is the only way this works, is by paying the difference off a LOC or the like, thereby keeping the $100 constantly going into the offset?

But then, doesn't the LOC need to be paid as well???

Sorry guys, I am confused. I've been doing a lot of research (maybe too much), I cannot seem to find a scenario that is CF positive so I've been looking a lot into serviceability. But again, all I find is that the speel re: "you can have this for only $75pw" or whatever isn't actually accurate. As that $75 is only on the IO loan, not accounting for PM expenses, rates, water etc etc.

Am I right here? Even a spread I've downloaded from this forum that presents the same out of pocket scenario doesn't seem to account for the actual expenses used to provide the tax variation..

Anyway, a bit of a ramble, sorry. Any feedback is appreciated.

Mo.
 
Strategy works great if you have a pile of equity on your IPs to use. But as the interest keeps capitalising, so does your negative gearing losses. OK for 1 or 2 IPs but doing them over a dozen or so wipes your equity very quickly. I heard ATO is also looking over debt re-cycling with IPs, suggests that you can get away with doing one property but when applied over a portfolio on a mass scale, Part IVA will kick in.
 
I don't have an IP (yet), is this strategy worth looking at?

100k equity in ppor
Looking to use equity to purchase IP of about 320k.

But my goal is to pay down ppor obviously, and I'd heard that channeling rent etc into offset would do this, but it becomes a revolving door when rent into offset, rent out of offset to pay interest etc. Not sure if this is the way to do it. I'll read that thread.

Cheers
 
asdf said:
Strategy works great if you have a pile of equity on your IPs to use. But as the interest keeps capitalising, so does your negative gearing losses.

Hi asdf

No, the negative gearing deductions grow thus your tax refund grows.
Now work out what happens to your non deductible interest payments and what your net position is:eek:

Cheers

Pete
Click to expand...
 
mo_cheeks said:
Ok, I don't want to make this more painful than is needed for those of you who are all over this, but I have a similar question:

But then, doesn't the LOC need to be paid as well???

Mo.
Click to expand...

Hi,

Yes, LOC has to be paid in some point. One way is either to decrease the PPOR home loan amount and apply for increase in LOC amount, service LOC on LOC. PRO- decrease non tax deductable debt. CON- not good for PPOR turn IP in future. Second option, when the property valur rise, apply for a valuation of property and hence you can top up your LOC.

PPOR interest are non tax-deductible. Assume interest is 7%
IP's interest is tax deductible... so is interest of LOC (Assume 100% of LOC is used for investment purposes only). Assume interest is 7.1% for LOC.

You do pay more before the tax man comes. But after tax - the real interest rate for PPOR - still 7% (non tax deduct) BUT IP - 7.1% x 0.7= 4.97% (Assume 30% tax rate hence getting 30cent per dollar back, leaving you really have to pay the 70 cent per dollar)

So after tax return, the IP LOC interest rate is < PPOR interest rate. this is the +ve.

as long as LOC has $ to service itself, i would 1. pay off PPOR debt as soon and as much as i can while LOC feed onto LOC. 2.when you hit the limit of your LOC, you then have to service it.
 
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