With his experience as a mortgage broker and real estate advisor, Philippe Brach was perfectly placed to give advice. Here's what he recommends:
1. How can Terry use his own funds to pay off his mortgage sooner?
The short answer is that it is useless to use equity in your investment property to pay off your home loan. I hear a lot of investors coming up with this idea, mistakenly believing that if you take out a loan on your investment property, the loan will be tax deductible. However, the tax deductibility of a loan depends on its use, not the asset that secures it.
You can therefore borrow money from your PDR to invest in real estate (for deposit, for example), and the amount you borrow to spend in your investment property is fully tax deductible. In addition, you can borrow on your investment property to invest in another investment property, which would be deductible.
However, if you borrow money on your investment property to repay your home loan in PPOR, the purpose of this loan is to help you make a non-deductible investment (your home) and you can not claim a tax deduction. on the interests. In other words, it is useless to extract equity from any loan to repay a loan at prepayment rate.
Furthermore, I would urge investors who extract assets from their home by investing in real estate to create a separate service, rather than simply completing their home loan in PPOR.
As previously stated, the home loan is not tax deductible. As a result, if you mix deductible and non-deductible items in the same account, it becomes very complicated to allocate the amount of deductible interest and that of others. If you can not convincingly prove how you calculated the distribution, the ATO may refuse the full amount of the interest.
Therefore, it is best to separate your non-deductible loans from your deductible loans. It's also a good financial management to keep your business (ie your investment properties) separate from your private business (living expenses, home equity, etc.).
That said, there are other simple ways to pay off your home loan sooner. The most powerful is to set up a clearing account against your home loan.
A matching account is a fully transactional savings account linked to your home loan. At the end of the month, the bank will calculate the interest you owe taking into account the net amount between your loan and your counterparty account. For example, if your loan is $ 400,000 and you have $ 50,000 in your offset account, the bank will charge interest on $ 350,000.
In other words, your clearing account will earn interest at the same rate you will pay on your mortgage. If you pay 4.5% of your mortgage, this would be equivalent to receiving 4.5% of your savings, net of taxes, much better than the 1.5% you could get in a savings account (a profit on which you must pay taxes). !) In Terry's case, on a 39% income tax rate, the interest that he would receive after tax in a normal savings account would only be around 0%. , 9%.
However, if your home loan is contracted from a no-frills Internet lender, like Terry, he will not offer you a matching account. In this case, you can set up a current account for your normal monthly transactions (incoming salary and expenses), and any money remaining at the end of the month can be transferred to pay off your loan, thus leaving the current account with a minimum. balanced. If significant unexpected expenses are to be paid, the loan repayment mechanism (which is not fully transactional) can be used by transferring money to your checking account to settle these bills.
Another tip is to pay your mortgage every two weeks rather than every month. Lenders calculate the interest daily, so it makes sense to make an additional payment in the middle of the month as this will help you shorten the term of your loan.
2. Should Terry transfer his property in trust to pay less tax?
Transfer properties into an apparent trust on the sale of assets. This triggers a change of ownership, which means that Terry would be subject to the capital gains tax as a seller – and, as a buyer, the trust is liable for stamp duty.
The tax deductibility of a loan is determined by its use, not by the asset that secures it
There are very few exceptions where stamp duty is exempt; they are generally limited to asset allocation following a divorce or the death of a spouse. However, a tax on capital gains could still be due. Terry would need an official legal opinion about it.
Even if you decide to transfer your real estate to a trust, despite the problems described above, you will face new barriers. A standard Newish property with a mortgage loan with a loan-to-value ratio of 80% would normally generate a tax loss that you can not distribute from a family trust (or discretionary). Tax losses remain in quarantine in the trust unless you have other income in the trust to "absorb" those losses.
You can use a trust unit, where negative conversion is still possible, but you can not choose who benefits from the distribution because this is dictated by the property of the unit in the trust.
In addition, the 50% capital gains reduction is not available if a property is in a discretionary trust.
In other words, it is unlikely that Terry will transfer a property that he owns in trust, that it is a common fund or a trust fund. a discretionary fund. Trying to use a hybrid trust, which has features common to both a discretionary trust and a unit, will not be an option either, for the same reasons – and banks are also reluctant to lend money. hybrid trusts.
It should be noted that, in the case of Terry, his wife does not work. He owns all properties in his own name, which entitles him to all tax deductions. So, the current structure that it has put in place seems to be tax-optimal under the current circumstances.
Transfer properties in an apparent trust to the sale of assets. This triggers a change of ownership, which means that Terry would be subject to the capital gains tax as a vendor
3. More generally, what should Terry's strategy be?
Several aspects need to be taken into account, including borrowing capacity, loan structuring and risk management.
While Terry has been very successful in acquiring four properties, he currently has no borrowing capacity to continue investing or even refinancing, given the tightening of lending criteria. In addition, his wife expects a child, which will further reduce his ability to borrow or refinance.
Its current loans are offered at very competitive prices, so there is no reason to refinance in the short term. A problem may arise later when his investment property loans return to P & I, as he may not have refinancing options elsewhere unless his financial situation changes. For example, his wife could return to work at some point, or his salary could increase over time, which would allow him to explore certain options.
The next aspect is the loan structure. Terry has three investment properties, mortgaged at attractive rates, all on the basis of interest only. He has a credit card, which is refunded in full every month, and he has no personal loan. His mortgage is on a P & I basis, with no clearing account but with a favorable rate of 3.59%, and he uses the withdrawal facility to minimize the cost of his interest.
Overall, Terry's credit structure is sound because it allows him to focus on repaying his most expensive debt first: his home loan.
Terry's properties having a positive cash flow before tax, so it's pointless to consider extracting equity from his house to put in place a separate funding mechanism for cash requirements of its investment properties.
To repay his loan to the PSPP more quickly, I suggest that Terry dedicate all his cash benefits (after tax) to him.
Finally, a note on risk management. All three of Terry's investment properties are in Tasmania – concentrated in the Hobart area – which is acceptable for the moment, but will be exposed as the market turns to that location. It would be better for Terry to invest in other parts of Australia, as many real estate markets peak at different times. The spread of location risk is always the best scenario.
Again, in Terry's case, he does not have the ability to invest in additional properties at the moment. However, if he was to sell some of his properties in Hobart and reinvest in Victoria, New South Wales or Queensland, he could probably get a loan for a property, but would struggle to finance two properties to replace those he had at Hobart.
In addition, he should pay a capital gains tax on sales, and then pay stamp duty on the acquisition of new properties. So, overall, it is probably best to keep your wallet as is.
He may want to sell one, if he feels the market is running, just to cash in some of the value created in the current cycle. He could then use the proceeds to further repay his PPOR mortgage.
The decision to sell one of the properties is a personal decision. Does Terry prefer to reduce his loan in PPOR or is he comfortable in the ups and downs of the real estate market in Hobart?
Several factors must be taken into account when deciding on a strategy, including borrowing capacity, credit structure and risk management
Terry has been very successful at creating a portfolio of properties with low loan-to-value ratios and good returns. His credit structure is good, the interest rates are very competitive and he is really above his mortgage. He is clearly looking for ways to improve his debt level, especially his home. The only way for him to quickly reduce his home loan is to sell one of his investment properties and pay off the house debt with the proceeds from the sale.
The potential weak point of Terry's strategy is that all his properties are in the same place. Given his current low borrowing capacity, he can not do anything about it right now, but if his financial situation changes and that he becomes able to continue buying, I would definitely advise him to. expand its network and focus on other parts of the world. to come up.
Philippe Brach is the CEO of Multifocus Properties and Finance