Home gearing is where equity in the home is used as security for an investment loan. The equity in the property is the difference between its value and any outstanding home mortgage. Such loans are usually used to invest in a portfolio of shares, as an alternative to margin loans secured by the share portfolio itself.
These loans can be structured as either lines of credit or term loans with redraw facilities. Lines of credit are similar to overdrafts with the borrower having access to funds up to the credit limit over the period of the facility. Monies drawn down and subsequently repaid can be redrawn at a later date. Interest is payable only on the amount of the loan drawn down (however an annual commitment fee may be payable on the full amount of the line of credit).
In contrast, redraw facilities are generally loans fully drawn at commencement with a set principle and interest repayment schedule. Monies paid ahead of schedule may be redrawn at a later date. In both cases, there is no restriction placed on the use of the funds. However, from a tax perspective, deductibility of interest expense is limited to the portion of loan applied towards the acquisition and retention of income generating assets. Further information on the tax differences between lines of credit and redraw facilities is available in ATO TR 2000/2.
Arrangements commonly referred to as split loans are structured to enable an investor to direct all cash flow to initially paying down a non-deductible home mortgage before repaying the investment loan and the line of credit. In this case, the interest on the capitalised interest will not be fully deductible. These arrangements have been addressed by the Australian Tax Office in TD 2012/1.
Interest expense will only be deductible where the purpose of the loan is to acquire an income producing asset. For example, interest on a loan to acquire a vacant block of land would not be deductible as the future investment return is of a capital nature rather than an income nature.
Lower cost of finance. As the loan is secured by property, interest rates are often lower than when using shares or managed funds as security.
Borrow more and invest more. As the loan is secured by property, a higher loan to valuation ratio (LVR) may be possible.
No restrictions on what you invest in. Lenders are generally not concerned about the type of investment as the loan is secured by the property, not the investment.
There may be no need for any additional security.
Diversify into non-property assets. If the home is a person’s only major asset, then all their money is tied up in one asset class. Using their home equity to diversify into other asset classes is often a sound strategy.
Potentially pay less tax. Interest and any other loan costs will generally be tax-deductible if the investment is in income producing assets. Additional tax benefits, such as franking credits, may be available if the investment is in Australian shares.
There are no additional commitments or liabilities such as margin calls.
While the risks are the same as those for all gearing, there is also the additional risk that the home may have to be sold if the investments do not perform well enough in order to service the loan.
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