I typically strongly recommend to property investors to never contribute any cash into an investment property acquisition. I’m not suggesting that you should blindly borrow more and therefore pay more interest. What I am suggesting is that if you have cash to contribute towards an investment that you do so indirectly using an offset account.
Contribute cash into the offset instead
Instead of contributing your cash and only borrowing the difference (i.e. what you need), I suggest that you borrow 100% of the property’s cost and deposit any cash savings in a linked offset account. Let me explain using a simple example.
Peter buys an investment property for $600k and has $275k of cash to contribute towards this investment. The total cost of Peter’s property (including stamps, etc.) is $635k so Peter needs to borrow $360k. However, I would recommend that Peter borrow $635k and then deposit his cash ($275k) in an offset account. This means that he would only pay interest on the net difference (i.e. $360k) but he has crystallised the maximum tax-deductible loan.
Peter should be able to borrow $635k if he has equity in other property – whilst being careful to avoid cross-securitisation.
Here’s why it makes sense
There are a number of benefits associated with borrowing the maximum and depositing cash into the offset – some of which are discussed below:
1. It reduces your risk because it means that you have ready access to a large amount of cash savings in case of emergencies such as a change in personal circumstances, unexpected large property expenses and so on. Peter can withdraw the $275k of cash from the offset without any restrictions. Maintaining access to your cash is critical to ensuring you have a safe financial buffer.
2. Your circumstances might change in the future (employment, illness/accident, etc.) and/or the banks rules might tighten (reduce the amount they will lend you) which might negatively impact your borrowing capacity. I have always recommended that the best time to borrow is when you don’t need it. Therefore, if you have the opportunity to lock in a higher loan now, take it. This maximises your current and future options and costs you nothing.
3. As noted above, it crystallises the maximum tax-deductible loan. You only have one opportunity to set the maximum tax-deductible loan and that is when you first purchase an asset. You will have to live with how you finance the asset initially for the rest of the asset’s ownership period. That is, Peter cannot contribute his $275k of cash and then say one year later, change his mind and increase the loan from $360k to $635k to pull his cash out again – because the purpose for what he uses the additional funds will determine whether the loan is tax deductible or not.
Let me share a story about two clients. When we met these client’s, the husband was retired, and his wife was still working. They wanted to buy an investment property and had a large deposit – about 80% of the property’s value. We counselled them to borrow the max and put the cash in the offset (as described above). They couldn’t see any benefit as they thought since they were in (or near) retirement, that they probably won’t need the money (i.e. no changed or planned changes in circumstances). Despite this, they thankfully followed our advice. A few years later they unexpectedly decided to relocate i.e. move homes. This relocation required them to spend more. They easily facilitated this by drawing cash from the offset account. This meant that they didn’t need to borrow more monies which would have been non-tax deductible (home loan). Avoiding having a home loan in retirement is important. This story demonstrates that you never know what is around the corner and therefore you should always maximise your flexibility/options.
4. Preserving the cash in the offset gives Peter the option of reinvesting these monies in other asset/s in the future. For example, in 20 years’ time, the property might be worth say $2.5 million and assuming a conservative rental yield of 2.5% p.a., the property might generate say $60,000 to $65,000 of annual gross rental income. Interest on a $635k loan at 7% p.a. is $44,500. Therefore, Peter could withdraw all the cash from the offset at this time and it’s very likely that the net rental income will cover the total interest expense i.e. property will pay for itself. This means that Peter could safely withdraw the monies from the offset and invest them in the share market, another property, another investment altogether or use them for personal purposes.
5. Consider the situation where you would like to retire but your pension/income from super isn’t sufficient by itself (or you cannot access super yet). In this case, you could sell your investment property to facilitate retirement. However, if you have a large amount in the offset account, then alternatively you could gradually draw on these monies to fund retirement. This would allow you to hold onto the investment property for a longer period thereby enjoying the compounding benefits of capital growth.
The above four benefits are generic in nature. I find that there are often a few additional client-specific benefits associated with this loan structure too (depending on their circumstances and goals of course).
You need some credit advice
It is important that you engage an experienced professional that is licensed to provide credit advice (i.e. a mortgage broker) to review your position and recommend the best loan structure for you. I have discussed one loan structural consideration above but there are many to consider. It is also possible that the above structure isn’t appropriate for your circumstances. That’s why personalised advice is important.
We have credit, tax and financial advice licenses so we can provide holistic advice. Therefore, if you need help, don’t hesitate to reach out to us.
