Like me, if you have been taught to work hard, save everything and pay down the home loan quickly, please take 5 minutes and read this article I wrote recently.
Too often, people pay down a large amount of the loan on their principal place of residency (PPOR) and later on in life look to upgrade, to a bigger place while keeping their current property as an investment property (IP). This is when the dream of building a portfolio starts to become reality.
So why is this a bad thing? We have always been taught to work hard, save everything and pay down the home loan quickly. When the current property turns into an IP, the loan against this property is generally quite small (as they’ve paid down a considerable amount of the principle) – which means they can only claim a small amount of interest.
Generally speaking, it’s ideal to have all of your loans set up as interest only with a linked offset account so you can reduce your loan repayments considerably because you are only paying off the interest component of your loan while at the same time your offset savings account is working for you to even further reduce the amount of interest payable.
It is a popular option for Investors and Owner Occupiers as it helps to keep your monthly repayment costs to a minimum but it is also handy for home buyers who need to free up their cash flow. It remains important to not forget that while you are not paying anything off the principal amount of the home loan your actual loan amount itself will not reduce.
Here’s an example
Peter and Mary purchased their first home in 2010. A 3 bedroom house in the Sunshine VIC, for which they took out a $400,000 loan.
Now in 2016, Peter and Mary have paid their loan down to $250,000.
Peter and Mary had twins and have now decided they would like a bigger home, closer to Peter’s parents. As the current home was their first, they want to keep it as an investment.
Because Peter and Mary have paid down their loan to $250,000 – when this property becomes an IP, only $250,000 can be claimed interest on (approx. $12,500 per annum on 5% interest rate) which isn’t ideal as the property is now worth $600,000 and getting $500 a week in rent.
Peter and Mary want to use the equity in this home to purchase the next property which is not ideal as the equity he is wanting to access from his current home can’t be tax deductible as it is being used to purchase a PPOR.
In this instance Peter and Mary have not structured their loan correctly and as a result have reduced their tax deductible (IP) debt whilst increasing their non – deductible (PPOR) debt.
Rather than pay down their loan with principle and interest, Peter and Mary can put all of their savings (including what would be principle repayments) into an offset account which effectively gives you the same outcome as well as giving you access to your money when need be. Instead of paying their loan down to $250,000, they would have $150,000 sitting in the offset account and only paying interest on the remaining $250,000.
With $150,000 sitting in their offset account, Peter and Mary can take the funds out. This will bring the loan back up to $400,000. They can then use those funds towards their next PPOR. This way, Peter and Mary have increased their deductible debt (IP loan) back to its original level of $400,000 whilst reducing their non-deductible debt (PPOR loan) by $150,000.
Peter and Mary are now able to claim interest on a $400k loan (which is closer to $20,000 per annum on 5% interest rates).
Contact us for a FREE no obligation consultation or discuss strategies to correctly structure your loan on 03 8390 5855 or email [email protected]