All Topics / Finance / capitalising interest

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  • Profile photo of nejasnejas
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    @nejas
    Join Date: 2008
    Post Count: 20

    Can anyone point out the pro's and con's of capitalising interest? From what I understand if set up right your repayments from equity and the interest charged on that to repay your interest loan will be less than the capital growth of the property itself? A selfpaying IP? If you are using equity is that coming from an existing property or PPR, or from the IP? What happens to the ability to leverage when eating into equity?

    Cheers

    Profile photo of Scott No MatesScott No Mates
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    @scott-no-mates
    Join Date: 2005
    Post Count: 3,856

    As you are increasing your debt levels by borrowing from your equity (eg via a LOC) you are effectively reducing your ability to further leverage the property for any other purpose. Unless the property is experiencing rapid capital growth (and the bank will allow more frequent reassessment of the property's value) then you will hit a brick wall quite quickly.

    Profile photo of newbi2newbi2
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    @newbi2
    Join Date: 2008
    Post Count: 227

    It is of use when running a short to medium term development project to allow the project to be self sufficient whilst waiting to be completed and settlements to occur. Of course the obvious problem is if they dont sell. All comes down to the numbers and what risk you (and the beank) are prepared to wear.
    Mick

    Profile photo of TerrywTerryw
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    @terryw
    Join Date: 2001
    Post Count: 16,213

    If you borrow to pay interest on a investment property or capitalise the interest (same thing really), then this can free up money which can be used to pay down your non-deductible debt faster while increasing your tax deductions. Becareful as you don't want it look like a scheme to save tax.

    Terryw | Structuring Lawyers Pty Ltd / Loan Structuring Pty Ltd
    https://terryw.com.au/
    Email Me

    Lawyer, Mortgage Broker and Tax Advisor (Sydney based but advising Aust wide) http://Terryw.com.au/

    Profile photo of Joseph12Joseph12
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    @joseph12
    Join Date: 2008
    Post Count: 57

    Capitalising interest is:
    Ideal for owner occupier borrowers looking to free up cash for other
    purposes.
    Ideal for investors seeking to turn negative cash flow into positive cash
    flow on an investment property.
    Their are cash flow loan that can capitalise part of the interest payable is say the first few years of the loan. You would need to enquire with your varies banks, mortgage manager etc.

    Profile photo of nejasnejas
    Member
    @nejas
    Join Date: 2008
    Post Count: 20

    I understand freeing up funds to use elsewhere eg non deductable debt which I presume is your PPD. How though is using debt to pay debt turn neg into positive cashflow on an IP?
    Also by freeing up money that may be used to service another IP what of the equity being tapped into if you were going to leverage off that?
     I've read about IP's funding themselves and "buying time" when capitalising interest. But if the 7% capital growth is correct you may literally have to wait years to leverage especially in a downturn, is that correct? Has anyone capitalised on an IP with success?

    Profile photo of DexterJamblesDexterJambles
    Member
    @dexterjambles
    Join Date: 2008
    Post Count: 12

    I might just add a quick thought….

    Can you capitalise the interest on the LOC and place any cash flow into an offset account rather than paying the interest on the LOC itself?

    For example:

    • Mortgage: $100K
    • LOC: $40K debt, $20K available
    • Use $20K to make repayments on mortgage
    • Capitalise the interest from the LOC
    • Have any salary/rental income/etc. paid into an offset account against either the LOC or the mortgage (whichever has the highest interest rate)

    So although the LOC is decreasing, you are maximising the use of your income channels by offsetting against the highest interest rate while also ensuring it isn't tied up & can be used for future purchases (both IP & personal).

    Does this sound right?

    Profile photo of TerrywTerryw
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    @terryw
    Join Date: 2001
    Post Count: 16,213

    Dexter

    I had some discussions on this with an exATO guy and he suggested something similar. You would be borrowing to pay investment expenses which is acceptable business practice, but there is still a risk the ATO will deem it a scheme to reduce tax. It may also help to have the LOC and the home loan at a different bank – to make it look less like that capitalising interest product from the Hart's case. Not paying down the PPOR loan, but having an offset would also look better than paying the loan down.

    Terryw | Structuring Lawyers Pty Ltd / Loan Structuring Pty Ltd
    https://terryw.com.au/
    Email Me

    Lawyer, Mortgage Broker and Tax Advisor (Sydney based but advising Aust wide) http://Terryw.com.au/

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