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The Importance of Loan Structures – Three Factors that are Often Over-Looked.

05 May 2013

While most people focus solely or predominantly on rates and fees when deciding on the appropriate loan, there are many other factors that should be considered and too often aren’t. For more sophisticated investors, including those with several properties, high income borrowers and those investing in commercial properties, this is even more so. Below are some of the more important factors in choosing a loan that are often ignored at the detriment of the borrower:

 

Flexibility of Access to Funds 

While rate is important, to the sophisticated investor, this is secondary to finding access to adequate funds when required. To demonstrate my point, consider the example of Jane and Tim, who own 3 investment properties and are now looking to purchase a commercial property through their family trust and are looking at suggestions from two lenders, Lender A and Lender B as to how to best structure their debt. Lender A is offering a rate of Bank New Business 5.2% by cross-collaterising all residential properties. However this lender will charge business rates for any cash out against these properties used for the purpose of buying commercial property and will conduct annual reviews. Lender B charges 5.5% but does not need to cross collaterise and allows access to equity in residential property for business use at business rates and no annual reviews. While to the novice investor, Lender A may appear more attractive due to lower rates and simpler structure with properties consolidated under one loan, this structure contains a number of pitfalls that will only become apparent as Jane and Tim look to add to their property portfolio or sell property. Lender B will most likely provide a structure that will enable them to draw on equity for the purposes they want and not be subject to undue interference from their bank. This will be worth far more than 0.3% extra on the rate, particularly if the bulk of their debt is tax deductible.

 

Maximising Tax Deductibility 

The general rule of a loan structure is to facilitate the paying down of all non-deductible debts before any deductible debts. The beauty of offset accounts for debts against principle places of residence (PPOR’s) is that they enable the interest on non-deductible debts to be reduced while still retaining easy access to funds. For those owning multiple properties, such as Jane and Tim above, it is also important that deductible and non-deductible debts be clearly differentiated in separate loan accounts. For those investors with multiple investment properties, the income from these properties can be used as a tool to pay down the PPOR as quickly as possible by depositing rental income in an offset account attached to the PPOR loan, thus reducing interest payable on this loan. Be careful though that the structure that you use is compliant with ATO rulings. It is suggested that your broker or banker work with your accountant on ensuring this is the case. For those using trust structures, it is even more important that there is a healthy dialogue between broker/banker and accountant.

 

Simplicity

As a general rule, it is important to keep things as simple as possible for book keeping purposes and keeping track of your loans, both for the purpose of doing your tax, and for your own management of your loans. It is amazing how many people we come across who are unsure of how much they owe against their property investments. This is generally the result of cross-collaterised loan structures that don’t clearly differentiate the property. Such a structure creates a nightmare for your accountant when doing your tax and can result in mixing of personal and investment debt. In most cases I would recommend that investors maintain separate loan accounts for each property in order to avoid this problem. 

There are many other factors when choosing an appropriate loan, and rates and fees are one of those considerations, but if you are wanting to make sure that your loans are structured to most benefit you in achieving your investment goals you need to look more deeply into how your debt is structured. Considering the above three factors will provide you with a good start.

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