Most people rush into the decision of choosing a lender and loan to meet tight settlement deadlines or to get the cheapest rate! However, it is certainly worth spending some extra time to get the right advice and choose a loan product and debt structure that will ultimately help you to achieve your goals sooner.
Before you choose the right loan with the right features, we recommend you ask yourself the following questions:
- What is the purpose of the loan?
- More specifically is it personal debt (e.g. a home loan, which is not tax deductible) or investment debt (e.g. a loan to purchase an investment property, which may be tax deductible)?
- Will the purpose of the loan change in the future (e.g. are you buying a home, which you intend to convert to an investment property in the future or vice versa)?
- Will you have the capacity to save money over and above your loan repayments and living expenses?
- How soon do you want to purchase your next property (either home or investment)?
- Do you have any events in your life approaching that you are planning to fund out of savings or your personal cashflow (e.g. holidays, car purchase, etc..)?
The answers to these questions will help you to determine the home loan or investment loan features that are important to you. This will ensure that the loan you chose gives you the ultimate combination of cost, flexibility and tax effectiveness.
A few of the popular loan features include:
- Offset Accounts
- Multiple Offset Accounts
- Line of Credits
We’re going to explain each of these features in detail, explain what type of investor would use this feature and also discuss their pros and cons. Many of these features are considered by property investors so if you would like to learn more about property investing, click here.
If you make additional repayments over and above your minimum repayments, redraw gives you the ability to access these funds at a later date. Redrawing from an investment loan isn’t a good idea as it can impact the tax deductibility of the loan. However, redraw may be beneficial for your home loan. This is if you are 100% certain that you will never turn your current home into an investment property. If you are uncertain as to whether your existing home will be converted to an investment property in the future, it is best to avoid using the redraw feature, as any redraw made from the loan for personal use whilst you were living in the house, may still impact the tax deductibility of the loan once your home becomes an investment property.
- Saving money in the loan will ultimately save you interest over the life of the loan. This helps you to pay off your loan sooner.
- Redraw comes as a standard feature on most variable loans.
- Redrawing out of an investment loan for personal use may impact the tax deductibility of the loan. You need to be sure to discuss this with your accountant before redrawing from an investment loan.
- Some lenders charge a fee for redraw so if you plan to use this feature, ensure you know what this fee is.
- Many lenders also place restrictions on number of redraws per year and/or min/max redraw amount.
An offset account is a separate bank account that is linked to your loan account. The funds sitting in the offset account are deducted from the loan balance for the purpose of calculating interest on the loan. What type of investor would use an offset account?
- Almost every investor would benefit from having at least one offset account. Especially if the investor has a combination of good debt (not tax deductible) and bad debt (tax deductible).
- An offset account is great feature if you are looking to buying a new home and converting your existing home into an investment property. E.g. You can use your offset account to save your deposit on your new home, without reducing the loan against your current home (which may eventually be tax deductible once the property is converted to an investment property).
- An offset account can also be a great tool for an investor who wants to access equity in their existing property(ies) for future investing but does not want to start making repayments on this equity release until they purchase a new property. E.g. The cash released can sit in the offset account and whilst the balance of the offset matches the balance of the loan no repayments will be required for an Interest Only loan.
- You can reduce the interest expense on your loan without physically reducing the loan balance.
- A transactional offset account can replace your everyday bank account. For example, you can arrange for all of your income to go into the account and all expenses to come out so that you make the most of every dollar you receive when you receive it.
- Putting your savings into an offset account rather than directly into the loan account will give you maximum flexibility to change the purpose of your properties in the future (ie. From home to investment) whilst ensuring you maximise your bad debt and minimise your good debt.
- Funds saved in an offset account are generally easier and cheaper to access then funds deposited directly into your loan account (and later redrawn).
- Some products claim to provide an offset account but the offset may not be a 100% offset. This means that only a certain % of the funds in your offset account are actually offsetting your loan balance. So be sure to ask the question.
- Some lenders charge a slightly higher interest rate or additional fees to provide an offset facility.
- Because the funds in your offset account are so easy to access, you need to have discipline. This ensures you stick to your goals and spend your money wisely.
Multiple Offset Accounts
Several banks are now offering multiple offset accounts. This means that you can have several separate bank accounts for different purposes all offsetting one or multiple loan accounts. What type of investor would use multiple offset accounts?
- This is a fantastic feature for the investor who likes to keep money for different purposes in separate accounts.
- It is also great for the investor who has a large amount of cash (either through savings or equity release for future investment). If you have a large amount of cash it is better for this to sit in a separate account to the everyday account that is linked to the bank ATM card that you carry around with you everyday for security purposes.
- Multiple offset accounts allows you to make the most of each and every dollar you have. This is whilst allowing you to separate different categories of funds.
- Too many accounts can sometimes be confusing. If you are going to take advantage of this feature, make sure you learn how to nickname your accounts online. This ensures that you can quickly and easily identify which account is for what purpose.
- This feature is only available with a select few lenders. Some of these lenders will charge you extra fees for each additional offset account, whilst others will not.
Line of Credit
A line of credit is a little bit like having a big credit card but at home loan interest rates. It is essentially an everyday bank account with a large credit limit attached that you can access as you wish. You only pay interest on what you use from the line of credit because the repayments are always Interest Only. What type of investor would use line of credit?
- A line of credit can be a fantastic facility for non-tax deductible debt, which will always be non-tax deductible. However, if you plan to convert the property into an investment in the future make sure you are not using funds from the line of credit for personal expenditure.
- A line of credit may also come in handy for a large equity release. This would sit idle until you are ready to spend it on another property. However, once you have drawn the line of credit up to its maximum limit, you may want to consider changing loan products to reduce your interest rate.
- A line of credit can also come in handy if you are undertaking a construction and you have sufficient equity to be able to control the progress payments yourself (i.e. Rather than the bank controlling the progress payments).
- A line of credit gives the ultimate level of flexibility and control over your funds. I see a line of credit as your variable loan and offset account basically merged into the one account.
- If you are using your line of credit for your home loan (ie. Non-tax deductible), you can use this as your everyday bank account and have all your income paid directly into the Line of Credit facility and pay all of your bills straight from the facility. This will ultimately help you to pay off your home loan sooner. However, if you are managing your home loan in this way you need to be very disciplined. If not, your home debt may start increasing instead of decreasing.
- Some line of credits allow for capitalisation of interest (i.e. The interest repayments are paid by the line of credit which results in the balance of the line of credit increasing), whilst other line of credit products do not provide this feature and require you to make regular repayments from a separate account. Be sure to understand which line of credit you are going to end up with. This ensures that you can manage your repayments.
- Generally, the interest rate and fees are more expensive for a line of credit.
- In many cases, the ATO does not like capitalisation of interest. For this reason, they generally look closely at investors who utilise Line of Credits in their debt structure.
Along with the loan features detailed above, there are many other different features you may consider valuable in a loan product, including:
- Umbrella Limits – where you have an umbrella debt limit approved and can split this limit however you like.
- Ability to make extra repayments – where you are able to reduce the balance of the loan faster without penalty.
- Honeymoon rates – where the interest rate is lower in the first few years of the loan then reverts to a more expensive rate.
- Portable loans – where you can keep the loan but change the security property.
- Repayment holiday – where you can put a hold on your repayments for a period of time.
Regardless of what you are looking for in a loan, the good news is that we are currently in a lending environment where there is a huge amount of competition and ultimately the borrower is the winner. With the variety of lender and loan options available, it’s so important to get the right advice before making a decision. Spend your time researching for a good mortgage broker. It is an extra plus if they are also an investor who understands property investing and has a great reputation and great client feedback.
It may also be worth considering refinancing your current loan product to a different lender to include some of the features mentioned above or consolidating your existing debts to reduce overall interest payable and monthly repayments.
Finding the right mortgage broking partner, will not only save you a huge amount of time, but will also help to save you money and will proactively achieve your future goals.
The right mortgage broker will go through your short term and long term priorities to identify the features that will help you to achieve your goals and ensure that you are only paying for features you need. The right mortgage broker will also have strong bargaining power with the banks and will be able to get you a far better deal than what you can get from the banks directly.
If you want to know more about your options please leave your details below and we will be in touch.