Looking to borrow or refinance? Here are five things your accountant wants you to know first.
If you currently have a mortgage or you are in the market to acquire one, you will know that 2023 is an expensive year to be alive! Before you head to your bank or mortgage broker, below are some things to be aware of first.
- Any tax debt will work against you
There may be a few exceptions but, as a general rule, the majority of lenders will not finance to retail clients (i.e. for your home loan or investment property) if you have tax debt. This is even the case if your debt is in a complying payment arrangement. What this means is, if you are purchasing, you will likely need to reduce your deposit funds by any tax debts, as you will need to pay these out first.
- There are impacts to lodging your tax return early
If you were thinking about borrowing (or refinancing) and you absolutely blitzed it in 2023, chances are you’ve already been to visit your accountant to get your 2023 tax returns done (nice work!). If you’re self-employed and 2023 was a larger than usual year for you, it’s quite likely that you’ll owe the Australian Taxation Office at lodgement time. If you lodge through a tax agent, that means you have until either March or May next year to lodge.
In a normal scenario, our advice would be to have your returns prepared early (so you know what is due) but to hold off lodging the returns to the Australian Taxation Office until the actual return is due. Historically it has been the case that to be able to use your 2023 accounts for financing purposes, the bank would need copies of Business Activity Statements lodged and a letter from your accountant confirming your income and that your return was finalised. We are hearing more and more from clients and their brokers that banks are requiring physical lodgement of their tax returns. Whilst pragmatically, if you want to borrow from a certain bank, you need to play by their rules, it is worth DOUBLE CHECKING that they definitely need lodgement of the returns.
There are a few reasons for this:
- It can bring forward the payment due date of your return by multiple months (no small thing in the current rate interest climate if the cash could be sitting on your offset instead!).
- It changes your “future income tax liability” into an actual tax liability – showing on the ATO portal – which could impact your ability to obtain any other forms of finance until it is repaid.
- It will increase your quarterly Pay As You Go (PAYG) Income Tax Instalments moving forward. The Australian Taxation Office base your quarterly PAYG Income Tax Instalments on your most recently lodged return. This means that if your 2023 taxable income was substantially larger, your 2024 income tax instalments will increase significantly. Whilst this is not necessarily a dealbreaker, you will need to factor these increased instalments into your cashflow.
It’s definitely worth asking your broker or bank the question to see if there is any way you can defer lodgement of the returns.
- It’s what you borrow for (not what you secure against) that counts tax wise
This might sound obvious, but this rule has caused heartache for a number of people we’ve spoken to who didn’t have proper advice when financing. The main time it applies is when people are upgrading their main residence and keeping the existing property as a rental. They often want to draw out the equity in their existing property to help fund the upgrade. This is especially the case where they’ve been super diligent on the mortgage repayments and paid down a large amount of the loan.
Whilst the new loan is secured against the rental property and is effectively just ‘topping back up’ the old loan, the purpose of the loan is to purchase your main residence and therefore the interest isn’t tax deductible. You can end up with the worst of all worlds (tax wise) which is a positively geared rental property and a main residence with a large (non-deductible) interest bill.
- Paying out your debt isn’t necessarily the smartest thing (utilise your offset account)
The best way to get around the interest deductibility issue discussed at #3 is to utilise your offset account rather than paying additional repayments towards your loan.
Whilst the balance in your offset account reduces the amount of interest the bank charges you, it doesn’t reduce (or tinker with) the underlying loan itself. What this means is that (from a tax perspective) you are best to borrow the largest amount possible and then utilise your offset function. The result is that you ‘preserve’ the loan amount so that if the property ends up being income producing at any point, your loan is still intact and you can utilise the benefits of gearing.
It’s worth mentioning that offset accounts can generally only be utilised against variable rate loans. If you’ve managed to lock in a fixed interest rate at 2020 prices, (good work!) then this is a strategy that you’d implement once the fixed term rolls off.
- Split loans are a great idea
When the bank or broker is setting up your loans, they will likely ask you if you would prefer one larger loan amount or to have the loan split into a number of smaller loans. Unless it is going to cost you significantly more, having a number of smaller loans is a great option.
There are a few reasons why having multiple/split loans are helpful:
- It allows you to have part of your loan on variable interest rate and part of it on fixed – so you can hedge your bets when it comes to interest rates whilst still having a level of certainty around your monthly outgoings.
- It allows you access to multiple offset accounts – which are really helpful in terms of saving strategy. If you are a sole trader or run a business, we highly recommend having an offset account that you use to save for your tax that is separate to your main offset account.
- It allows you to pay down one of these smaller loans and use it for tax deductible purposes. This is a great strategy if you were wanting to utilise this cash for a deposit on a rental property or to purchase shares etc. It ensures that this part of the borrowing remains tax deductible, but it means that you don’t need to draw additional debt over and above your existing loan amount.
By Elissa Lippiatt, Chartered Accountant and Director
This article first appeared in the November 2023 issues of the News Bulletin, published by the Australian Dental Association https://www.ada.org.au/Dental-Professionals/Publications/News-Bulletin