Investing!
Investment property home loans differ from your normal home owners loans in two main ways;
- The interest that is paid on them is tax deductible.
- Investors are not usually focused on paying off the loan, Home owners are.
With those two factors in mind the perfect structure for investment property home loans has one more variable and that if there is any existing personal debt on the family home.
In this article I am making the assumption that there is a home loan but that there is equity available in the home.
I have set up this type of loan structure for many of my clients, particularly those that are looking to buy their first Investment property. There is a great deal of satisfaction in helping my clients take this sometimes daunting step into securing their financial future.
OK so lets set some parameters for my example;
The Simpson’s own a home in Eastwood, a suburb of Sydney. The property is valued at $700000.00. The Simpson’s current outstanding home loan balance is $200000.00. The original loan was for $500000.00 and they are fortunate that their loan allows them to redraw funds at no cost and they also have the ability to “split” the loan.
Naturally an integral part of any loan assessment is “serviceability” or your ability to repay the loan. For the purpose of this exercise we are going to assume the Simpson’s have substantial incomes and will have no problems borrowing up to an additional one million dollars.
Another major criteria that a bank looks at is your credit history. Once again we are assuming that the Simpson’s have an excellent credit history.
The Simpson’s have been researching units in the Eastwood area and have found a new 2 bedroom unit for sale with a tenant already occupying the unit on a 12 months lease.
The negotiated price for the unit is $500000.00 and the rental payments are $500.00 per week. The purchasing costs will be $30000.00 including things like stamp duty, legal fees, bank costs etc. The total cost to buy this unit will be $530000.00
Here is the deal we would put to the Simpson’s existing bank. This arrangement or structure will give the Simpson’s the following benefits;
- Flexibility to make further investments when they are ready to.
- Maximum tax benefits.
- Assist in the ongoing reduction of their home loan.
Firstly we will ask the bank to create a “split” in their existing home loan. What this means is that because original loan was for $500000.00, and currently has a balance owing is $200000.00, the Simpson’s have an available redraw of $300000.00.
We will ask the bank to create a split for $130000.00. This figure will cover the costs to buy as mentioned above, as well as the 20% deposit that the bank requires.
So now the Simpson’s will have a home loan with total available funds of $500000.00 that has been split two ways.
-The original home loan is now “split No. 1 of $370000.00 and remains as a loan for their home, IE personal use and not tax deductible. This loan will continue to be paid on a principle and interest basis.
-The New Split No. 2 of $130000.00. This loan is specifically for investment purposes and as such the interest charged will be tax deductible. This loan will be paid as interest only.
The Simpson’s will receive 2 sets of statements which makes it easy for both them and their accountant to calculate the tax deductible interest components.
Secondly we will apply to their existing bank OR if they are not competitive, another bank, for a new stand alone loan for $400000.00. Here is the basis of the application;
Security; The bank will not want to lend more than 80% of the value of the property (with out asking for Mortgage insurance – an additional). We have this covered as $400000.00 is 80% of the purchase price which is $500000.00.
Serviceability; We mentioned before the Simpson’s were able to borrow an additional 1 million dollars, but remember that the rental that they will now be receiving forms a part of that equation.
Credit History; Excellent!
We know that we will have no problem with our submission and the new loan arrangements and application will be approved.
I use this type of structure for my clients as I believe it offers the best overall package at a minimal set up cost. I am always trying to keep your existing relationship in place with your current bank as this means less costs for you. There are however 2 exceptions;
- You don’t want to stay. That’s fine with me, after all it is your loan not mine!!!
- Your existing banking arrangements are non-competitive. There are costs involved in refinancing, and some times those costs can be so high that even staying with a non competitive bank (for the time being) will still be the best option. I can only advise on that depending on your personal circumstances.
Here is what we have achieved for the Simpson’s and their Investment Property Home Loans Structure;
- They have used $130000.00 of the equity that they have in their home to leverage into their first investment property. A great move towards their financial future.
- They still have available equity in their home loan to the value of $170000.00 to use as leverage for future investments.
- They have maximized the tax deduct ability of the funds that they have borrowed.
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