LOAN STRUCTURING ADVICE
What is loan structuring?
There are three areas in which a loan and its underlying asset can be structured. The actual loan type chosen, the asset ownership structure and borrowing entity, and how equity in existing properties is utilised.
The correct loan structuring advice can increase the tax effectiveness of your loans, help protect your assets, and can make restructuring your loans when your circumstances change easier.
At Mortgage Experts , we can suggest loan structures that we think will be the most effective for any given scenario. We will often work with our clients’ other trusted professionals to determine the best outcomes for our clients. Please do not rely solely on our information below to make any decisions as the information is general in nature.
1. Choosing the right loan type and features
Should you go for a line of credit, an interest only loan, a loan with a 100% offset account, a plain old principle and interest loan or something else?
The truth is for the most simple of borrowing situations it probably doesn't really matter that much. However once your affairs become more complex or you are planning to acquire multiple properties in the future it does start to matter. This is where some good advice upfront can potentially save you many thousands of dollars in the future.
Many a time we see borrowers, other brokers and bank managers focussing their energies on the specifics of a loan itself such as small differences between lenders fees and interest rates. Instead they should be looking at the bigger picture first then the product second. As the example below shows choosing the right product can end up saving you considerably more than a potentialy small difference in interest rate between two loans. That is not to say that we can't get you both the right product and the best rate, often we can, however it pays to keep focussed on ones strategy first not the best rate offered today.
Example of choosing the right product: Interest only loan with offset account
Many first time buyers purchase properties with the intention to turn them into investment properties in the future when they upgrade to a larger or better property. In their circumstances an effective structure would be to use an interest-only loan with a mortgage offset account.
The strategy would be to funnel any repayments above the minimum required on the interest-only loan into the offset account. This would do three things:
- Having funds accumulating in an offset account would effectively mean that the borrower would not pay any extra interest on the loan. This is as compared to a standard principle and interest loan, and provided they paid at least the difference between the interest only and the principle and interest repayments into the offset account each month.
- In the future when the property becomes an investment, they would have a loan for the same amount as initially borrowed and on which the interest charged would be fully tax deductible. This is opposed to if they had made repayments off the principal of the loan. This would then mean the loan balance and therefore interest claimable would be less.
- Any funds accumulated in the offset account could at that point be used towards the next purchase.
In summary, this structure works for the borrower as they have not be penalised by paying any more interest on their loan than they would have if taking a more traditional loan. And they have maximised their future tax deductibility for when their property becomes an investment.
For any given scenario there is usually a correct loan product to choose. Get it right the first time by contacting the Mortgage Experts.
2. Loan structuring for asset protection
Many self-employed borrowers in highly litigious industries should consider the best structure to purchase a property in to protect their asset.
Title in one name for a husband and wife scenario
If borrowers are a husband and wife or a de facto couple, and only one is self employed in a highly litigious industry, then often the best ownership structure would be to have the party that is not involved in the business as the sole owner of the property. The loan could then be set up in joint names if allowed by the chosen lender, or if not allowed the non-owner could act as a guarantor for their partner if needed.
Owning via a trust
A trust is an arrangement which allows a person or company to own assets on behalf of another person, family or group of people. These people are known as the beneficiaries of the trust. Assets are owned on behalf of “beneficiaries” and are controlled by a “trustee” who can be either a corporation or a natural person. The trustee is governed by a “trust deed” which sets out the rules that the trustee must follow. It also covers how profit is distributed to the beneficiaries.
If a borrower is single or both partners are involved in high risk industries then perhaps a trust structure would be worth considering. There are a few different types of trusts, but not all are accepted by lenders. If you don’t have a trust set up yet, we recommended you go with a family trust (this is a type of discretionary trust). This is the most common and widely accepted trust by lenders. To fully protect yourself we recommend you opt for a corporate trustee (however seek advice). Below is an example of the loan structure for a family trust.
Example of a trust ownership structure:
Rob Smith owns a commercial construction business. His industry is notoriously litigious due to work sites in general being dangerous places. Rob is single and looking to buy a home for himself. Rob sees his accountant and sets up a family trust and a new special purpose company that is to be trustee for his family trust. Rob is the sole director and shareholder of the trustee company.
Owner / mortgage holder: Rob Smith Pty Ltd (as trustee for The Smith Family Trust)
Borrower: Rob Smith Pty Ltd (as trustee for The Smith Family Trust)
Guarantor: Rob Smith
There can be variations on this, where the borrower is the individual and the guarantor is the trustee company. There may be some tax advantages if set up this way and the property is an investment.
However the more complicated the trust or structure the less lenders will be willing to do the loan for you. They need to be clear on how and from whom to get their money back if there is a problem!
Go to our dedicated loans to trusts page for more on trusts.
3. Loan structuring for investors
Most investors use the equity in one or more properties to allow them to purchase another. We believe that great care should be taken in how these loans are structured. Please go to our cross collateralisation V standalone page for more.