While no tax deduction is available for interest on a regular home loan, opportunities can exist when the home is rented out for a period of time, or equity in the family home is used to fund other investments. In recent months there has been an increasing gap between the rates offered on owner-occupied versus investment loans, which creates an opportunity.
Housing loans are usually the largest borrowings that most people will ever take out, and are often their first significant financial transaction. The tax position is quite simple to start with – if you borrow for a property that you will be living in then nothing can be claimed.
This can change, however, once you’ve paid down some of your home mortgage and are starting to think about making other investments. This is where some careful planning can save you thousands both in interest and in tax savings.
Accessing equity in your home for investments
One common scenario is, for example, where you have borrowed $500,000 to buy a house costing $750,000, and after a few years you have been able to pay the loan down to a balance of $300,000, while the house may now be worth $950,000. You have been making extra loan repayments, and might have undrawn borrowing capacity of say $150,000, possibly even more if you were to refinance based on the current property value.
You decide that you wish to invest $100,000 in shares, and arrange with your bank to create a new ‘interest-only’ loan of $100,000 under your existing loan facility, secured against your family home. As the new borrowing is used entirely for investment purposes, all of the interest on that loan would be tax-deductible against the dividends from the shares.
It’s likely in the current environment that doing it this way may allow you to access a lower interest rate than under a stand-alone investment loan. Keeping it separate from the amount still owing on your house makes the calculations for your tax return a lot simpler, while the interest-only arrangement maximises your tax deductions. Any loan repayments should go against the home loan, not the investment loan.
Renting out your home
Renting out the family home is more common than many people realise. It may be because you have received an interstate or overseas posting, you decide to move back in with your parents for a while to build up your savings, or even where a couple each own a property and they move into the property owned by one partner and rent out the other one.
In these cases, any interest on the home loan will become tax-deductible against the rent on the home. If you later move back into the property, any interest on the loan will again become non-deductible from that point on.
These scenarios can also work well for capital gains tax (CGT), as your main residence is exempt from CGT, and the exemption can remain in place for up to six years after you move out, as long as you first lived in the property. There is no specific time limit, but you would need evidence to show that you were genuinely living there.
It is important to be aware that if you do things the other way around, for instance if you buy a property, rent it out for a couple of years and then move in, CGT would apply to the period before it actually became your main residence.
Another factor to be aware of is that, if your plan is to live in the property for only a short time before starting to rent it out, you may have an obligation to disclose this to the bank when applying for a loan, as interest rates on investment properties are often higher than for owner-occupied properties, and not to disclose your intentions may breach your mortgage agreement.