John McGrath's 5 tips for reorganising your debt to invest
With a huge number of investors active in the Australian property market, John McGrath of McGrath Estate Agents has compiled a list of tips on reorganising debt for investing.
Tip 1: Principal and Interest Loans vs Interest-Only Loans
A typical scenario for investors is that they will own their own home, with a mortgage, and will plan to use the equity available to fund or partly-fund an investment purchase.
Most owner-occupiers will have a Principal and Interest loan on their home. P & I loans are excellent for owner-occupiers because your equity increases as you pay off the principal. If you’re going to remain living in your home, staying on a P & I loan is a good idea because the interest is not tax-deductible so that’s the debt you want to pay off first with spare cash.
However, the interest on the loan for an investment property is tax deductible, so you might like to take out an interest-only loan on your investment property. Because you don’t pay off any of the principal, the regular repayments are less than a P & I loan. Thus, you have more cash in your pocket, which allows you to borrow more and buy more property!
Tip 2: Freeing up cash flow
Freeing up additional cash flow is a priority for most investors. One of the things you could do is convert the home loan on your principal place of residence to interest only as well. This would put more money in your pocket, but the downside is you won’t be paying off any of the principal and the interest remains non-tax deductible. But what if you moved out?
Tip 3: Take advantage of tax deductibles
If you moved out of your home and rented it out, while renting somewhere cheaper yourself, you could free up a lot of cash flow. If you converted the loan to interest only, you’d have even more cash available and the interest would be 100% tax deductible too. Plus, you could claim all the expenses of the property, such as strata levies, council rates and water rates, as a tax deduction too. But what about capital gains tax, I hear you say?
Tip 4: Use the six year rule to avoid capital gains tax
If you rent out your principal place of residence, the Tax Office will allow you to do this for six years with no exposure to capital gains tax (CGT). You receive all the benefits, such as rental income and deductibility of expenses and loan interest, but you won’t have to pay capital gains tax if you sell it within six years. After six years is up, you can move back in and re-qualify for another six years if you move out again. This is a generous opportunity that could save you thousands in capital gains tax if you ever decide to sell the asset. (Click here to read more about the six year rule.)
Tip 5: Variable vs Fixed Rate Loans
Finally, a word on fixed and variable rates. Fixed rates give you peace of mind but little flexibility. But today’s fixed rates are extremely attractive and well below variable rates, so it might be worth considering locking in below 5% for a couple of years while you’re getting used to having not only a home loan but also an investment loan to manage too.
McGrath advises as each situation may differ, it is best to discuss individual circumstances with financial advisors.
McGrath's tips were published on the financial planning website Switzer.
