Refinance or use cash?

13/10/2011


Question: I've been paying my PPOR diligently over the past three years and brought down my LVR to 60%. My broker advised that I could top it up to 90% and use this as a deposit to buy a new house or two units as an investment. I also have some cash (about $60,000) sitting in my offset account so I'm wondering if it's better to use this money rather than take out about $70,000 from my PPOR?


Answer: While I have respect for most brokers, please be very careful when you are taking ‘advice’ from them.  A broker is able to outline for you the features and benefits of a loan, but unless they are also a qualified financial adviser, they are not able to give you advice about how to structure your personal, investment or tax affairs. 

There are a lot of issues here for you, so let’s look at them one at a time.

Firstly a strategy requiring you to borrow 90% of your equity is a risky one and leaves you very exposed.  You will have little margin available for value movement, and if you get into any sort of trouble early in the piece and before you can repay some more debt, this could spell trouble for you. Add to that the fact that any loan over 80% will result in a  lender’s mortgage insurance premium being charged, and you may be even further behind the eight-ball in terms of equity.  Remember, the build up of equity is all important if a property strategy is going to work.

Secondly, if you do redraw your equity in this way, you must quarantine this new part of the debt from the original home loan.  Simply drawing back the existing loan will make accounting difficult since some of the loan will be personal and some for investment use.  Apportioning the interest is hard if the loans are not effectively separated out.

Thirdly, simply advising you to buy a new house or two units is careless.  What you buy must be the result of an abundance of research and after establishing what type of property the demographics of the area you ultimately choose demands.  In some areas houses are better, in some units, but in all cases you must firstly identify the area which possesses the best growth drivers at the moment.

Finally, and with regard to whether you should use the funds you hold in offset, the answer is no.  Using these funds will mean that there is $60,000 of your PPOR loan which you will now incur interest upon (which is currently offset), effectively increasing your repayments (or decreasing your debt repayment), and it will also mean that you will take out an investment loan which is $60,000 less than it would have been, as you have brought in cash for the purchase. 

You will then essentially have a higher personal debt and a lower investment debt, and be upside down financially. It is better to keep your personal debt offset with your cash and, as long as you quarantine the investment portion of the redraw, create a 100% loan to buy the investment property.  Once you have no personal debt, use the cash to offset or repay the investment debt.    
Answetr supplied by Margaret Lomas, Destiny Financial Solutions (www.destiny.net.au)

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