One of the most common financial steps people go through involves buying a new family home which is of a better standard then their last one. This is a natural progression as people settle into careers, have more disposable income and build families.
Often people decide to keep the previous property as an investment and use the rental income to assist with repaying the new debt and building wealth. There is a trap with this scenario that can lead to a poor taxation outcome. This makes repaying the debt take significantly longer due to the limited assistance from the tax man.
The issue is whether the interest on a loan is tax deductible or not. Most people in this situation would be in the 34.5% or 39% tax bracket. That means that if their loan is tax deductible, they are getting a tax refund equivalent to over a third of their interest. Obviously the more of their debt that is tax deductible the better. If they are going to have debt against their own home and also debt against a rental property, they should ensure the debts are clearly separated so that any principal repayments can be coming off the ‘bad’, own home loan as it’s not tax deductible.
The key to whether a loan’s interest is tax deductible or not is what the money was used to purchase and not which property the bank takes a mortgage over. Generally, the family home doesn’t produce income and therefore loans where the money was used to purchase or renovate the property you live in are not tax deductible. Loans for rental properties or shares generally are tax deductible. Based on this, minimising the new loan against the new family home and consequently increasing the investment loan makes sense. Sometimes selling the old home, maximising the cash deposit on the new home, and buying a new rental property makes more sense however this needs careful analysis.
There are several strategies that can be used to decrease non-deductible debt and replace it with deductible debt and investments, and a range of flexible lending products to assist. As always seeking the advice of an experienced financial planning professional is advisable.
If you’d like an obligation free review of your situation, to maximise your lending structures, call us for an appointment today.
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