Redraw works for purchasing investment from home loan equity, or other IP equity.
My client, let’s call her Rachel, is planning on moving into this property for one to two years and renovating it during that time, before moving on to her next property and renting this one out. There are many things to think about when getting a mortgage but I am only going to look at the potential tax effects of different loan structures.
She has a mortgage broker that she has used before, so no need to introduce her to our new in-house broker but we did discuss the loan structures and how her intentions for the property can influence the type of loan that may be best for her.
As Rachel told me her intention is to live in the property and then rent it out, the first thing I brought up was an offset account and the differences between offset and redraw. An offset account is actually a separate account linked to your mortgage in such a way that the balance of the account is used to reduce the interest payable on your mortgage. So, by putting all available cash in your offset account, you are reducing the interest paid on your loan (and increasing the principal component of your repayments). This is different than a redraw facility where you make higher repayments, or deposit lump sums, to reduce the amount of your loan and therefore the interest payable.
For most people, the choice of one or both of these facilities is likely driven by rates and fees but if you are borrowing for an investment property (or potential rental property) then you should also consider these facilities from a tax perspective as the advantages and disadvantages can substantial.
As an example, let’s assume in 12 months’ time Rachel receives an inheritance of $200,000 and wants to reduce the interest on her mortgage. Her brother told her that she should just deposit it to her mortgage account and reduce her interest payments, then draw it back out when she buys a new house. She gives us another call to get our advice before doing anything. The table below compares putting the funds into an offset account or depositing straight to the loan with a redraw facility.
|Deposit to offset||$200,000||$0|
|Deposit to redraw facility||$0||$200,000|
|Interest calculated on:||$300,000||$300,000|
As you can see there is no difference in the amount used to calculate the interest each month. Now let’s fast forward to when Rachel has completed the reno’s and is ready to purchase a new home and rent this one out. She wants to use the $200,000 as her deposit to purchase this new property. Let’s see the example:
|Withdrawal from offset||$200,000||$0|
|Withdrawal from redraw||$0||$200,000|
|Total loan amount||$500,000||$500,000|
|Interest on loan (4.5%):||$22,500||$22,500|
|Investment loan amount:||$500,000||$300,000|
|Tax Deductible Interest:||$22,500||$13,500|
Now you can see the real benefit of the offset account comes when the purpose of the original property changes from private to investment. With an offset account Rachel can claim interest on the full loan amount as she only withdrew the savings from a bank account (albeit linked to her mortgage). As we can only claim interest on money used for investment purposes the interest on the amount Rachel ‘redrew’ for her new home is not tax deductible meaning difference in deductions against her new rental property of $9,000.
Remember to speak to your accountant about your personal situation and not take advice from the guys at the pub or footy club, or even in your family!