In this week’s episode #70 of the Property Planner, Buyer and Professor Podcast, the team discuss “Optimising tax deductions – top mortgage and loan strategy tips”, as Dave, Cate and Pete take you through:
- How can you optimise your tax deductions? Tax optimisation is multi-dimensional and you only have one opportunity to borrow funds to purchase an investment asset. There are many mortgage strategies you can put in place to ensure you’re getting the most bang for your buck.
- Using equity to maximise borrowings. Although counter-intuitive, maximising your investment loan can put you in a better financial position. The trio explain why you should consider borrowing the full purchase price plus costs of the investment if you have equity available in an existing property.
- Paying principle and interest on your home, and interest only on your investment loan. The aim of the game is to pay down your non-deductible debt as fast as possible, while preserving your deductible debt to make holding your investment property more affordable.
- Preserving the balance of your home loan if you plan to upgrade. This is a critical point to consider for anyone who has purchased a stepping stone home and has plans to keep their home as an investment when upgrading to the long-term home. The Property Planner outlines the mortgage strategies that can be employed to make the most of your future tax deductions.
- Why do so many people get this wrong? Many of us are taught by our parents and grandparents to pay down debt as fast as possible, without realising that you may be shooting yourself in the foot and killing wealth. We advocate that everyone should pay down their debt by using the right strategy, which will hold you in great stead when you transition to the flexibility stage of life.
- Redraw v offset accounts. The Property Planner explains the difference between redraw and offset accounts, and why the smart use of offset accounts means you could end up with an extra asset or two in your retirement.
- Understanding the ATO test for deductibility. Ultimately, the ATO decides what expenses are deductible and what is not and understanding the ATO ‘purpose test’ is key. The trio explain the ‘purpose test’ and how it works in simple terms.
- And of course, our “gold nuggets”!
Weekly market insights:
- RBA revises low interest rate forecast. Governor of the RBA Phillip Lowe has said that he expects interest rates to remain low for the next 4 years, extending from his previous forecast of 3 years. In addition, there are no concerns on the horizon about an asset bubble forming for the property and share markets. It’s game on!
- Demand spikes for hot property. At the coal face, we’re seeing floods of prospective buyers at open for inspections, with not everyone in the queue able to inspect the property. Supply is not dramatically shorter, but the numbers of buyers have gone through the roof. The last time there was this much activity was after the GFC where the government was throwing money at first time buyers and interest rates dropped to 5%. Now, rates are even lower, stimulus is greater, and consumer sentiment has spiked; creating the perfect storm to propel the property market.
- Comparative sales. In light of demand and market movements, if you’re interested in purchasing a property, you should be looking at comparative sales from the last 2 to 4 weeks. Anything over that is too old in many markets, and likely to give you dated sales results to depend on.
- Property predictions. The trio share their predictions for when regulators will step in with macro prudential measures to dampen property market activity and run-away prices. They also share their individual insights into how they feel the measures will be rolled out.
- What does optimising tax deductions mean?
- You have one opportunity to borrow money to purchase an investment asset. There are many different things you can do in your mortgage strategy to ensure you are getting the most tax deductions you are legally able to.
- Might be for today or preserving tax deductions for the future – it’s multi-dimensional. Thinking forward so you don’t bugger up the tax deductions you can get later.
- Borrowing to purchase investments
- If you do have equity in existing properties – it make sense to borrow the full purchase price plus costs. It means your loan is larger and you can claim the most amount of tax deductions.
- If you have non-deductible debt, you want to save your cash to reduce this. Because it’s not tax deductible it’s more expensive.
- Let’s say your home loan is 3% and your investment rate is a bit higher. Once you reduce it via your tax rate, it actually ends up lower than your home loan rate.
- Pay principle and interest on your home and interest only on your investment loan
- Your home is not deductible, so therefore you want to be paying that down and putting all surplus cash flow to paying down the debt or offsetting it.
- Pay interest only on the investment loans, so that all of your cash is going towards paying down the more expensive debt.
- Don’t make additional repayments on your home
- If there is any possibility that your current home is not your long-term home.
- Every dollar you pay down, you cannot claim back as a tax deduction, when that home becomes an investment.
- Having to sell property you could have kept, is a wealth killer.
- Why do so many people stuff this up?
- Our parents and grandparents who grew up during tough times, taught us to pay down all debt as quick as possible.
- Good debt, is borrowing on money on an asset that increases in value.
- Bad debt, is borrowing money on an asset that is depreciating. Or no asset at all.
- The property grows faster than inflation and is how you will build your wealth.
- What is the difference between redraw and offset account?
- Each loan is another account, it’s just a bank account with a negative balance.
- If you make extra repayments over and above the minimum repayment, you can then access via ‘redraw’. If you access via redraw and spend it on something else, that money is not related to the property that you initially purchased with that account.
- The ATO purpose test
- The purpose of what the money is spent on, determines whether it is deductible or not. Not, what the security for the loan is.
- You can use your home as security to buy an investment property, and you can claim this as a deduction, because the purpose of the borrowed funds, is for investment.
- Not where the funds originate from, it’s what they’re used for.
- The offset account
- Offset accounts give you the best of both worlds. Every dollar which goes into an offset, which is completely separate to your loan, like a regular savings account. Reduces the interest.
- But if this goes into an offset account, you can put that money towards your future home to reduce the non-deductible debt.
- You are much more likely to be able to hold that asset.
- It might also mean an extra asset or two to put towards your retirement.
- If you get it right with the offset account set up, you’ll end up in a better financial position in the long-term.
- One of the biggest regrets that we hear people have, is not purchasing when they could have and also selling when they could have kept.
- Using equity to maximise borrowings
- When someone’s buying an investment property, we want them to be in a position to borrow the full amount, plus the stamps and costs.
- We want to be borrowing 105%.
- If done well, you’ll be set up.
- When you redraw money from a loan, what was that money spent on?
David Johnston- The Property Planner’s Golden nugget: we got a wonderful LinkedIn email from a client of ours. He said:
“Hope you are having a good start to what I am sure will be a very busy year for you given the current property climate.
We have just settled on our second investment property and used your mortgage broking service. I have left a google review and will do the same on Facebook but I wanted to message you personally to say what a great job Seth Winkles and the team did with our loans.
Over the past couple of years I have listened to a lot of property podcasts to increase my knowledge on the right way to invest in property and a common theme is to use a strategic mortgage broker. I thought I had one who did our PPR home but then when I used them for my 1st investment property I could see that they weren’t at all and didn’t structure my loans the right way, etc. I then started talking to another mortgage broker and could tell straight away that they were not what I was looking for either.
I was listening to your podcast one day and I thought why not give Property Planning Australia a call as a Strategic Mortgage Broker has been staring me in the face this whole time. I am so glad I did because from the first conversation with Seth I knew he was what I was looking for as he talked about ways to structure our loans (which made me either madder at my last mortgage broker for not doing this in the first place) and how to tackle the process, etc which was what I was looking for.
The rest is history and he got the job done and now I have the 2nd investment property and a much better loan structure. Sorry for the long message but I thought it was important to share my experience with your company and give credit where it is due for Seth as he really did a great job and knows his stuff.
Looking forward to the next property!”
Peter Koulizos – The Property Professor’s Golden nugget: you should never be buying property for the tax deductions, they are the icing on the cake. But you don’t want to buy a cake because it’s got beautiful icing and underneath the icing, the cake is rubbish!