Setting up my first IP correctly

[Endless]

Hi all! Long time lurker and observer here.

I am about to start the process of buying my first IP in Melbourne, and want to make sure I set things up the best I can now. I have done lots of reading here, but could do with some of your opinions as well.

I don't have much of a long term strategy as of yet, I just want to start out with the one IP and see how things pan out as I go. I may end up buying more and starting to work on a portfolio, or I may decide two properties are enough and move to Bali and be a hippy instead!

I am currently in the highest tax bracket (47%?), and will be for another 6 months at least. Job security may change after that time. I have my PPOR in Perth, purchased for $450k two years ago, now with $390k remaining and 100k in the offset. I would say it's still worth roughly the same now. My budget for an IP is around the $500-$600k mark, and after rent I don't want to be out of pocket by more than $300 a week, obviously the less I'm out of pocket the better.
I'm thinking it's best to use the equity from my existing PPOR to buy the investment, but I'm not sure if I should go with an IO or P&I loan at the moment. I'm sure I can change from one to the other down the track, but there would be fees involved? Also, if using my equity from PPOR, do I have to stay with the same lender? I am worried about the two properties being tied to each other if using equity as a deposit on the IP.
I have more questions, but I think this is a good start for now

Thanks in advance!

 

[Colin Rice]

The first step would be to get a valuation done on your PPOR to determine what the value actually therefore the available equity. In many cases this can be done upfront with out submitting an application. A property purchased 2 years ago should be worth more know as Perth has seen a fair amount of growth since then.

Use the equity available in your PPOR first as opposed to your cash as funds borrowed for investment purposes are tax deductible whereas your own cash is not. Depending on your plans for your current PPOR it would be worth considering using some of the 100k in offset to reduce the debt on the PPOR and re-borrowing as this will also create tax delectable debt.

Go interest only on both your PPOR and the new IP. Fees or not to change down the track will depend on the lender you are with but in a lot of cases it is $0 or minimum
fees. When you take into account the cash flow benefits it is usually negligible.

No you do not have to stay with the same lender and you can have your properties stand alone either at the same lender or a different lender.

What lender are you currently with?

 

[Endless]

The first step would be to get a valuation done on your PPOR to determine what the value actually therefore the available equity. In many cases this can be done upfront with out submitting an application. A property purchased 2 years ago should be worth more know as Perth has seen a fair amount of growth since then.

Use the equity available in your PPOR first as opposed to your cash as funds borrowed for investment purposes are tax deductible whereas your own cash is not. Depending on your plans for your current PPOR it would be worth considering using some of the 100k in offset to reduce the debt on the PPOR and re-borrowing as this will also create tax delectable debt.

Go interest only on both your PPOR and the new IP. Fees or not to change down the track will depend on the lender you are with but in a lot of cases it is $0 or minimum
fees. When you take into account the cash flow benefits it is usually negligible.

No you do not have to stay with the same lender and you can have your properties stand alone either at the same lender or a different lender.

What lender are you currently with?

Thanks for the reply Colin.
You are suggesting having the IP loan as IO to get the most amount of positive cash flow from the property?
My PPOR loan is with Bankwest. I will get a bank val done in the next month or so hopefully, and the result of that will tell me if I need to move some funds from the offset onto the PPOR loan.

 

[Jess Peletier]

Regardless of the valuation, moving funds from the offset into the ppor and redrawing them via a new loan split is a much more tax effective way to structure the loan. Using the offset funds leaves a high PPOR debt and uses cash for the IP rather than borrowed funds. Ideally you want to borrow 100% plus costs for the IP.

A higher valuation will just be a bonus.

 

[Colin Rice]

Thanks for the reply Colin.
You are suggesting having the IP loan as IO to get the most amount of positive cash flow from the property?
My PPOR loan is with Bankwest. I will get a bank val done in the next month or so hopefully, and the result of that will tell me if I need to move some funds from the offset onto the PPOR loan.

I would suggest having the IP and PPOR on interest only. Not referring to a positive cash flow for the IP although an IO loan will help, its more to do with overall cash flow and retaining control rather than the bank.

Do you have plans to remain in your PPOR long term or will this be converted to a rental property sometime in the future?

Bankwest offer upfront vals to "Premium Brokers" and rather than going the DIY route, it would be best to get some help with this as it is important to consider the implications from a tax perspective in conjunction with your accountant before shifting funds around to convert non deductible debt to deductible debt.

Unless you re 100% confident then its possible to DIY but this is rare in my experience and can cause more harm than good in the long run. Generally speaking banks pay no heed to this important consideration.

 

[Endless]

Regardless of the valuation, moving funds from the offset into the ppor and redrawing them via a new loan split is a much more tax effective way to structure the loan. Using the offset funds leaves a high PPOR debt and uses cash for the IP rather than borrowed funds. Ideally you want to borrow 100% plus costs for the IP.

A higher valuation will just be a bonus.

Thanks Jess

I would suggest having the IP and PPOR on interest only. Not referring to a positive cash flow for the IP although an IO loan will help, its more to do with overall cash flow and retaining control rather than the bank.

Do you have plans to remain in your PPOR long term or will this be converted to a rental property sometime in the future?

Bankwest offer upfront vals to "Premium Brokers" and rather than going the DIY route, it would be best to get some help with this as it is important to consider the implications from a tax perspective in conjunction with your accountant before shifting funds around to convert non deductible debt to deductible debt.

Unless you re 100% confident then its possible to DIY but this is rare in my experience and can cause more harm than good in the long run. Generally speaking banks pay no heed to this important consideration.

I plan to live in my PPOR for at least another few years, after that it's hard to say. I'd like to keep my options open at the moment. Can you explain how an IO loan gives you more 'control'?

 

[Colin Rice]

I plan to live in my PPOR for at least another few years, after that it's hard to say. I'd like to keep my options open at the moment. Can you explain how an IO loan gives you more 'control'?

Yes, you make an agreement with the bank to pay them the interest only on your mortgage/s and retain the principle amount in your offset account.

You get the same net result as a P&I agreement but you keep the money in your control rather than giving it back to the bank. That way you get to decide what happens to the principal therefore gaining more control.

Plus when you convert your PPOR to an IP you have preserved the principal/original loan amount therefore having a greater interest deduction at tax time. If you never convert your PPOR to an IP then no harm done. I call it "hedging your bets"!

 

[Endless]

Yes, you make an agreement with the bank to pay them the interest only on your mortgage/s and retain the principle amount in your offset account.

You get the same net result as a P&I agreement but you keep the money in your control rather than giving it back to the bank. That way you get to decide what happens to the principal therefore gaining more control.

Plus when you convert your PPOR to an IP you have preserved the principal/original loan amount therefore having a greater interest deduction at tax time. If you never convert your PPOR to an IP then no harm done. I call it "hedging your bets"!

Great, that makes sense.
So when using existing equity to purchase an IP, could I include all my purchasing costs and fees into the borrowed amount? Also, I presume by doing this there are tax benefits and deductions that are claimable?

 

[Colin Rice]

In short yes, but as always get advice from your accountant.

Its possible to set up a buffer to pay not only upfront costs but ongoing costs as well.

In regards to paying LMI (if applicable) it depends on the lender how they disburse the LMI premium. For example Bankwest will distribute it proportionally over the loan splits where CBA will add the entire premium as instructed. Regardless of bank quirks it is still a tax deductable expense.

 

[albanga]

I call it "hedging your bets"!

I totally understand the merit of this but would always advise to tread very carefully with this. Point being yoir offset is simply cash savings and can be very very easily accessed. If you have poor money skills, a wife that likes holidays (Yep that's me) or are short sighted then this can be risky as opposed to paying down the debt.

Whilst I understand you can likely just redraw that anyways it is different than popping your card into the ATM at chadstone and dropping $1000. It's quite easy to spend the money you MIGHT save if you decide to turn your PPOR into an IP.

 

[Colin Rice]

Hi Albanga,

Its not a blanket rule and the question is always asked if this strategy will cause any issues as you have alluded to.

I always collect a "Fact Find" first before meeting face to face and a cursory glance at an A&L will indicate wether such a strategy is appropriate. In 95% of cases it clearly is or is not.

 

[Endless]

In short yes, but as always get advice from your accountant.

Its possible to set up a buffer to pay not only upfront costs but ongoing costs as well.

In regards to paying LMI (if applicable) it depends on the lender how they disburse the LMI premium. For example Bankwest will distribute it proportionally over the loan splits where CBA will add the entire premium as instructed. Regardless of bank quirks it is still a tax deductable expense.

More good advice. I will look into the buffer option to minimise out of pocket expenses. I can also understand why some people have issues holding large amounts of money in the offset accounts. It works for me though.... As long as there is no card attached to the account, it makes it pretty tedious to withdraw money, and that seems to keep me away from all those funds haha!

 

[Colin Rice]

I can also understand why some people have issues holding large amounts of money in the offset accounts. It works for me though.... As long as there is no card attached to the account, it makes it pretty tedious to withdraw money, and that seems to keep me away from all those funds haha!

There are a number of ways of accomplishing this ^^^^^ if required/desired depending on your bank.

 

[Terry_w]

Don't forget to carefully consider ownership structure as well as finance structure.