Forums / Getting Technical / Finance / Equity release, Offset or Line of Credit?

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  • Profile photo of StevenSteven
    Participant
    @steven1982
    Join Date: 2017
    Post Count: 155

    Hi all

    As per title. While not doing any form of equity release at this stage, but I do have some questions in this regard.

    Both method promises that “there will be 0 interest charged until the money is being taken out”.

    a) In LOC scenario, I was explained I can think of it kind of like a “credit card”, that if I don’t use the money, there is no interest.

    b) In the offset scenario, I was explained that one can take the equity out in the form of a “separate loan (do not top up the existing home loan as it can get very very messy) that is IO + 100% offset, and then park the whole money into offset so effectively it generates 0 interest. And Interest is only generated once I take the money out of the offset”.

    So both methods are similar in this regard, that I do not get charged Interested unless I take money out. So then what is the real difference between the two? Which method is the cheaper option? What are the pros and cons of either?

    If I were to release equity to be used as deposit for the next investment, which method is more preferred?

    Profile photo of JaxonJaxon
    Participant
    @jaxona
    Join Date: 2014
    Post Count: 282

    Are you talking about equity in a property>?

    so the offset only offsets the amount in the offset

    e.g.

    100k loan, 60k in offset, pay interest on 40k

    Profile photo of StevenSteven
    Participant
    @steven1982
    Join Date: 2017
    Post Count: 155

    No I mean like this:

    I have a 500K property, with 400K existing loan.
    Over time the property value increased and a valuation report produced by bank indicated the value of the property is now say 600K
    so in theory, at 80% LVR, I can take another 80K (600*80%=480. 480-400=80)

    But rather than “topping up” the existing home loan from 400 to 480, the loan is restructured so it becomes 2 loans:

    first loan is still the existing loan with 400K
    Second loan is the equity released loan with 80K, and borrow it as IO + 100% offset

    I then park the whole 80k into the second loan, making it produce 0 interest (meaning 0 repayment as well since it is IO), while at the same time I continue to pay the 400K repayment as usual.

    ——————————–

    So question is whether this method is more preferred over “line of credit” method?

    Profile photo of JaxonJaxon
    Participant
    @jaxona
    Join Date: 2014
    Post Count: 282

    If you restructure your loan goes up.

    so from 400k loan to 480k loan.

    I have no idea what your goal or reason or even what your trying to work out.

    debt is debt, you still have to pay for it if you use it.

    may as well just refinance your property and put equity in offset on that same loan. so your cash is liquid if needed

    Profile photo of StevenSteven
    Participant
    @steven1982
    Join Date: 2017
    Post Count: 155

    Yes, I am fully aware that the loan goes up, but I don’t want to “top up my existing loan”.

    So suppose currently my accounts look like this:

    Account 1: 400K loan
    Account 2: Offset for 400K

    After the equity is released, based on my own studying, I see that there is a choice of the following (there could be more choices but so far I see there are those 3):

    Choice 1: Line of Credit, so my accounts look like this:

    Account 1: 400K loan
    Account 2: Offset for 400K
    Account 3: My Line of Credit of 80K

    Choice 2: top up existing loan so my accounts will look like this:
    Account 1: 480K loan
    Account 2: Offset for 480K

    Choice 3: restructure the loan so my accounts look like this:
    Account 1: 400K loan
    Account 2: Offset for the 400K
    Account 3: 80K loan
    Account 4: Offset for the 80K

    Between Choice 2 and 3, I would rather avoid Choice 2 if I can.

    The reason is because:

    1. the 80K is to be used as a cash deposit for the next investment and I don’t want to pay interest for that 80K unless that 80K is actually being used. This is why I park that 80K into Account #4 above so that 80K loan generates 0 interest until I use that money.

    2. Of course I get what you are saying, just top it up to a single 480K loan and park that 80k into the offset of the 480K loan (which is essentially choice 2). But problem with that is, how do I know how much interest is charged for my 400K loan for that IP and how much interest is charged for that 80K that is used for the next investment? It becomes an accounting nightmare. So separating them out is much easier to manage from that accounting and taxing perspective.

    ———————————————

    So regardless of whether you agree with this or not, my initial question is very simple:

    Is it better to take that 80K out as a line of credit — Choice 1
    Or is it better to take that 80K out as a separate loan? — Choice 3

    What is really the difference between Choice 1 or 3?

    • This reply was modified 1 year, 7 months ago by Profile photo of Steven Steven.
    Profile photo of TerrywTerryw
    Participant
    @terryw
    Join Date: 2001
    Post Count: 16,110

    Consider the tax issues.

    Interest is deductible if you borrow to invest.

    With the offset account strategy you are borrowing to place money in a savings account. At some later date you may invest the money. Can you save you have borrowed to invest?

    You may say you can trace the borrowings to the loan. But what happens if you put cash into the offset with borrowed money?

    LOC on other hand are higher rates and are usually at call loans so not ideal.

    Solution. Get tax advice from a lawyer or a tax agent.

    Terryw | Structuring Lawyers / Loan Structuring Pty Ltd
    http://propertytaxbook.com.au/
    Email Me

    Lawyer, Mortgage Broker and Tax Advisor (Aust wide) http://propertytaxbook.com.au/

    Profile photo of StevenSteven
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    @steven1982
    Join Date: 2017
    Post Count: 155

    Hi Terry

    Understand where you are coming from. My concern however is I don’t know when the invest will happen.

    For example:

    I want to buy a new investment property and I really don’t know when I will find the right one. I might not find the right one for a while or I might purely by chance stumble across one that I really like, and when I do find one, I want to have the deposit ready rather than having to “wait for the deposit to be approved”.

    So with the interest only + offset strategy, the scenario come to my mind is like this:

    1. Suppose I take out 80K equity release as a separate loan, interest only + offset, and then I park the 80K into the offset, so it is not generating any interest what so ever.

    2. I am not able to find a property that I think is worth investing until March, meaning I incur 0 interest for 2 months. It also means I make 0 repayment for 2 months because this is an Interest Only loan and I am not paying any Principle (not until IO period is over anyway)

    3. During March, I found the right property and I spend that 80K to invest in that property, and bank start charging me interest since I used that 80K, and the interest starting from March becomes tax deducible

    4. Meaning starting from March, I can write the interest for that 80K off as cost against my profit.

    5. So yes, there are 2 months when I am not being charged any interest as I didn’t make use of that 80K, but I am also not making any repayment either, so there is nothing for me to lose during that 2 months.. but starting from March on wards, interest charged due to those 80K being spent on investment becomes tax deductible (unless I got this totally wrong and that interest from March on wards is not tax deducible?).

    Profile photo of TerrywTerryw
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    @terryw
    Join Date: 2001
    Post Count: 16,110

    Did you use borrowed money to invest or cash from the offset account?

    Terryw | Structuring Lawyers / Loan Structuring Pty Ltd
    http://propertytaxbook.com.au/
    Email Me

    Lawyer, Mortgage Broker and Tax Advisor (Aust wide) http://propertytaxbook.com.au/

    Profile photo of StevenSteven
    Participant
    @steven1982
    Join Date: 2017
    Post Count: 155

    I didn’t borrow any money yet, I am just asking and trying to understand the different options here.

    I apologize if I sound like I am asking stupid questions, but it is something I have never done before and I am trying to understand based on the information I read.

    In the example I gave, that 80K I put in offset are borrowed money. As in, it is the equity my lender released for me, so I did after all, borrow that 80K from a lender.

    So unless I got my understanding totally wrong, otherwise I would say that 80K is borrowed money, but temporally put into an offset account (different offset account from the offset account that is used for offset the original 400K loan).

    Like this:

    Account 1: 400K loan
    Account 2: Offset for the 400K <— This is were I put extra money to offset the interest for my original 400K loan
    Account 3: 80K loan
    Account 4: Offset for the 80K <– This offset account is created specifically for that 80K loan, it is an independent offset account than the one used to offset my original 400K loan, and I put the borrowed 80K into this account temporally until I use it

    Profile photo of JaxonJaxon
    Participant
    @jaxona
    Join Date: 2014
    Post Count: 282

    dude.

    your making such a complex thing.

    it can be as simple as one account.

    a account that is

    -400k balance
    with 80k that is accessible.

    Profile photo of TerrywTerryw
    Participant
    @terryw
    Join Date: 2001
    Post Count: 16,110

    What I am trying to say is by taking the borrowed funds on a detour you a muddying the waters of interest deductibility. It is not clear if the interest on the $80k loan would be deductible. However to improve your chances I would suggest just before using that $80k you should pay it back into the loan and then reborrow it.

    Terryw | Structuring Lawyers / Loan Structuring Pty Ltd
    http://propertytaxbook.com.au/
    Email Me

    Lawyer, Mortgage Broker and Tax Advisor (Aust wide) http://propertytaxbook.com.au/

    Profile photo of TerrywTerryw
    Participant
    @terryw
    Join Date: 2001
    Post Count: 16,110

    May not be a good idea to have just one loan as it would then be a mixed purpose loan which can create tax issues, especially if one purpose is not deductible.

    Terryw | Structuring Lawyers / Loan Structuring Pty Ltd
    http://propertytaxbook.com.au/
    Email Me

    Lawyer, Mortgage Broker and Tax Advisor (Aust wide) http://propertytaxbook.com.au/

    Profile photo of StevenSteven
    Participant
    @steven1982
    Join Date: 2017
    Post Count: 155

    Hi Jaxon

    In that case, are you able to advise how do I keep track of which invest against the combined total of the interest is being charged?

    Say, the original 400K gets charged 2000 per month Interest (Interest Only)
    Once I use that 80K, the interest becomes 2500 per month. (Interest Only)

    The numbers are not accurate, but for illustration purpose only.

    In this case, it might be easy to for me or for you to say say 2000 interest against original investment and 500 interest against new investment, but let’s throw in another variable here…

    What happens if the original 400K loan is for my Principle Home (PPOR) that is being repayed P&I rather than IO, and I am using equity of my PPOR to invest in a new IP?

    In this case, the interest for that original 400K loan would vary every month (due to I am paying Principle too), this means the monthly repayment for that single 480K is different every month.

    So if I just “top it up” and make that a 480K single account, then how do I tell how much of the combined total interest is for my PPOR (therefore NOT tax deducible) and how much of that combined total interest is for my new IP (which is tax deducible)? The calculation becomes a nightmare in this case…

    Profile photo of StevenSteven
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    @steven1982
    Join Date: 2017
    Post Count: 155

    What I am trying to say is by taking the borrowed funds on a detour you a muddying the waters of interest deductibility. It is not clear if the interest on the $80k loan would be deductible

    Hi Terry

    OK, so if both Line of Credit and Offset options are bad ideas (LOC being expensive in terms of interest rates and Offset being muddy with if interest is tax deducible), what would be a 3rd alternative based on your experience in that area?

    Profile photo of StevenSteven
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    @steven1982
    Join Date: 2017
    Post Count: 155

    May not be a good idea to have just one loan as it would then be a mixed purpose loan which can create tax issues, especially if one purpose is not deductible.

    Yea.. that’s exactly what I was trying to say all along

    A single loan with multiple purposes, it gets messy.

    Profile photo of TerrywTerryw
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    @terryw
    Join Date: 2001
    Post Count: 16,110

    I didn’t say either was a bad idea. There are only 2 products you could choose from – the LOC or the term loan.

    One strategy may be to use a LOC and then immediately convert it to a term loan after settlement.

    Terryw | Structuring Lawyers / Loan Structuring Pty Ltd
    http://propertytaxbook.com.au/
    Email Me

    Lawyer, Mortgage Broker and Tax Advisor (Aust wide) http://propertytaxbook.com.au/

    Profile photo of JaxonJaxon
    Participant
    @jaxona
    Join Date: 2014
    Post Count: 282

    To jump all this, as its futile IMO.

    both
    1) equity
    2) LOC

    are fine, the rates and fees and terms of that exact deal matter more than saying one or the other.

    but essentially under the right circumstance, they are both better or worse.

    so to end I will answer same as Terry.

    Solution. Get tax advice from a lawyer or a tax agent.

    Profile photo of StevenSteven
    Participant
    @steven1982
    Join Date: 2017
    Post Count: 155

    OK, that’s fine. Thanks for all the advice.

    But I have to say when I originally asked those questions, I was more thinking if someone can give some general information.

    For example, using “what’s the pros and cons of H&L package”, I would expect the answer to be “while in some exceptional circumstances, H&L package appreciate, but under most circumstances they do not appreciate”. Or something like “the PROs of H&L packages are ABCDE, while the cons are XYZ”.

    So much in the same manner, I was hoping someone could say “the PROs are LOC is blah blah blah (From what I read, one of the Pros of LOC is it is more flexible), while the cons are blah blah blah (again, from what I read, one of the Cons is LOC is more expensive interest wise). Also, at the other hand the PROs of taking it out as a separate IO + Offset loan is yadiyadiya while the Cons of doing it this way is this this that”. or something like “The key difference between LOC method and IO + Offset method is 12345”

    My expectation is very simple. I was inquiring Pros and Cons of each or someone can explain the difference between the two method (or more methods if there are more), but instead the whole conversation turned into “why do you want to know pros and cons of each”, which is really not goal of asking the questions at first place.

    Profile photo of TerrywTerryw
    Participant
    @terryw
    Join Date: 2001
    Post Count: 16,110

    I answered this above

    Terryw | Structuring Lawyers / Loan Structuring Pty Ltd
    http://propertytaxbook.com.au/
    Email Me

    Lawyer, Mortgage Broker and Tax Advisor (Aust wide) http://propertytaxbook.com.au/

    Profile photo of StevenSteven
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    @steven1982
    Join Date: 2017
    Post Count: 155

    Thanks Terry, your answers were helpful, much appreciated.

    My previous post wasn’t directed at you.

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