Second Mortgages

I own assets in my own name. What can I do to protect them?

As already discussed, there are things you can do.

You can transfer assets into a family trust or company or other structure, but you will be liable for stamp duty and (probably) capital gains tax, as well as having a 5 year clawback period under the bankruptcy laws. Or alternatively, you can set up family trusts, or companies, and use these structures to take a second mortgages or caveat over your assets.

We discuss second mortgages in this page. We take the family home and use this as an example. We will look briefly at investment properties further down.

Protecting your biggest asset – the family home

For every family, your main asset is your family home. And most commonly, the family home is bought in your own name, or more commonly, in joint names.

The issue arises, how would you protect your family home?

Let’s take an example of a family home worth $1 million where you have little or no debt but is in your own name. Clearly if someone sues you in business, your family home is at risk.

There are three ways you can protect your home from golddigging creditors …

Firstly, if you’re married or in a serious relationship (such as de facto), you can put your family home in the name of the person with a lower risk of being sued. For example, if a doctor is married to a retail shop employee, the retail shop employee is at lower risk of being sued. So he or she (the retail shop employee) would own the property in their own name.

Secondly, you could transfer the family home into a family trust managed by a corporate trustee. However, this will not only requires you to pay stamp duty upon the transfer but also means your home will no longer qualify as your principal place of residence. Consequently you couldn’t claim any capital gains tax (CGT) and land tax exemptions in relation to this property.

Thirdly, you can use a second mortgage or caveat strategy. That is, create debt to protect your home. By securing the majority of your equity in your house by a second mortgage, the property will appear fully encumbered. This will make your home far less attractive to potential creditors. In fact, it is well known in liquidations and bankruptcies as soon as the trustee in bankruptcy or liquidator (or the ATO) sees a second mortgage, they are less inclined to go after the house due to costs and inconvenience.

How does a second mortgage work?

One big benefit of this strategy compared to the second option is it is considerably cheaper. It allows you to keep your home as your principal place of residence, and have the CGT and land tax exemptions, while still getting significant asset protection.

There are a few steps involved. These are:

Step 1: Set up a Discretionary (Family) Trust

You can set up a family trust which through a series of transactions, will take a mortgage over your property. There are 2 ways you can do this:

  1. You fund it from an existing line of credit or redraw facility or cash reserves by gifting into the family trust (see below) and lending back to yourself
  2. You create all the transaction on paper

Keep in mind with 2, it may not be enforceable (although it is still a very effective smokescreen … please contact us to discuss further). Therefore, we are focusing on 1 in this article.

The great thing with a family trust is no single beneficiary (or group of beneficiaries) has any claim to the assets of the trust, ie. nobody actually owns the assets of the family trust. Therefore, in a lawsuit, or if you go bankrupt or have the government after your assets, in most cases the assets in the trust don’t form part of your personal assets, and aren’t available to your creditors.

You can use an existing family trust, but it depends on the situation.

To find out more about family trusts, Click Here.

Step 2: Get access to funds

It is always better, as stated above, to get access to real funds. You can do this by:

  1. Drawing from a redraw facility
  2. Drawing from a line of credit (getting one created at your bank)
  3. Using cash reserves (if you are cashed up)

To work out the best way for you, you should get professional advice.

Step 3: Make a Gift into the Trust

From there, you draw your funds, and put the cash into the family trust as a gift. The money should be physically transferred into the bank account of the trust.

Step 4: The trust lends the money back

The trust immediately pays the money back physically to you as an individual, but does it as a loan. The loan is then secured by a second mortgage over your family home, which you get a property lawyer to prepare, and have registered at the Land Titles Office.

If done properly, subject to some clawback rules for bankruptcy purposes, the trust ranks above all other creditors if you are sued, even though it is in your name and is your asset. (If you have a bank mortgage over the property, this gets first priority.)

The beauty of this is you keep your principal residence exemption for CGT purposes, and also land tax exemptions for the property. And you get asset protection almost as good as if you directly transferred the property into the trust itself, but at a lower cost.

You get your cake and eat it too!

WARNING: It is critical you get professional advice before doing this. Under bankruptcy law and other laws, there are provisions against defrauding creditors in certain situations. Although this can be done in a way which does not fall foul of these provisions, you should get it checked thoroughly first.

What about Protecting your Investment Properties?

As a comment, the strategy works very well with a family home, because you retain CGT exemption and land tax benefits, and avoid stamp duty. With investment properties, as you’d be liable to pay CGT and land tax anyway, the major benefit is stamp duty. Nevertheless, this can be significant.

The principles apply similarly to investment properties as for a family home.

How Do I Protect Myself with a Second Mortgage?

You can read more about asset protection at our Blog, or Click Here or read our frequently asked questions on asset protection, Click Here

Contact us today to ensure your assets are properly protected. You can either contact us on 1300 669 336 or click here to organize a free no obligation strategy session.
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