Should I be using cash or equity to buy?

If you want to build your property portfolio, you will soon run into the issue of where your next deposit is going to come from.

There are really only two ways to come up with a deposit and that’s either to save the money or use equity from another property. 

While we should certainly be looking at ways to get our cash to work hard for us, using those funds as a deposit on a property might actually be a mistake for many people.

That’s because when you have both deductible and non-deductible debt, you need to think carefully about where you are putting your money to work.

For example, if you have a PPOR that is worth around $1 million and your remaining mortgage is approximately $500,000, that means you have about $500,000 in equity.

At the same time, let’s assume you have savings of $200,000 as well, so now that you are looking to buy an investment property, you will need to think about the best way to do that.

While a lot of people would simply use that cash to buy an investment property, they could actually be better off and minimise their tax if they were to use equity.

To minimise your deductible debt what you should be doing is using that cash to pay off your non-deductible debt, which is your mortgage on your owner-occupier property.

That way you decrease your non-deductible debt from $500,000 to $300,000 if you put the $200,000 into it.

That then gives you the ability to redraw that $200,000.

Now you’ve got a $300,000 non-deductible mortgage and a $200,000 deductible mortgage which you have out as cash because it’s an equity release.

Then you can use that to cover the deposit and closing costs on the property.

That means that you’ve got a hundred per cent debt on the investment property that’s deductible and you’ve minimised your non-deductible debt on your owner-occupied property.

While the final result is the same in that you have purchased a similar property, you have actually been smart with the way you have done it. You are now maximising your position from a tax perspective.

While this might seem like a small thing to do, over time the results will be significant.

As your property profile grows not making the most of deductible debt can really slow down your progress.

Focus on getting the basics right and the rest will fall into place.

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