A home equity loan is often promoted as a specific product and is normally another name for a line of credit however this is certainly not the only way to access the equity on in your home. For the purpose of this page we are discussing using the equity in your family home for investment purposes. While you may also set up a small facility for personal use as part of the structure a purely personal use facility would be considered a ‘supplementary loan’ rather than a home equity loan.A line of credit is an ‘interest only’ loan that can offer enormous flexibility and is very useful for people looking to invest in property or shares. Particularly where you want the ability to make quick decisions such as purchasing a batch of shares or placing a deposit and snapping up a property. However it often comes at a higher interest rate or fees and some people feel that it is difficult to control their spending.
Another trap with lines of credit is that they don’t always offer the flexibility that you need. Unfortunately banking products often have the same name but come with very different features and benefits. For example your accountant may mention the possibility of using a line of credit (LOC) to improve the gearing of your borrowing – in layman’s terms this means trying to move your non-deductible debt onto your deductible debt. Without going into the structure or the legality of this, if the advice is sound then in order to make this work you require an LOC that allows unrestricted interest capitalisation (up to the loan limit). While many lenders will claim that their product allows interest capitalisation there are often restrictions which render the product unsuitable to fit with the advice you have received. Amazingly many lenders and many brokers don’t understand this and a mistake here can cost you many thousands of dollars.
ALERT The Australian Taxation Office currently has ruling on Part IVA with a wide interpretation on the deductibility of capitalised interest and the use of a line of credit to service investment debt. As a result of this we suggest that you seek professional taxation advice on the use of a line of credit to service investment property debt.
So while a line of credit is great for some investors it isn’t required for everyone. Let’s say that you have a specific property in mind or maybe plan to construct a property – if you have time to plan ahead then the instant flexibility that the line of credit offers is no longer required. In this case you simply arrange for an additional loan account/s – you must never use redraw on the loan securing your primary place of residence (family home) for investment purposes without written advice from your tax advisor. There are very important potential tax implications in doing so. This doesn’t mean that you can’t use the equity that you have in your family home for investment purposes – it simply means that you have to structure it correctly.
Just as a line of credit can be established for investment purposes secured by your family home, other loan types can at times be more suitable but still secured against the family home and still deductible. For example if you were purchasing a Defence Home with secure income flow and controlled overheads you may consider a fixed rate loan. If you are building an investment property then generally a line of credit is out of the question and you need a construction loan – but do you need a variable rate or a fixed rate construction loan ….. that’s why you need an experienced mortgage broker.
Using the equity that you have in your family home is the most common way for people to kick off their investment strategy and there are many other issues to consider such as cross collateralisation (not always the demon that is portrayed) or borrowing all of the setup costs and maximising your deductions. We have over 18 years experience with thousands of investors large and small on our client list and we can assist you.