This Factsheet explains what loans and mortgages are and the impact that they may have on income support payments (service pension and income support supplement) paid by DVA.
What are loans and mortgages?
A loan is a financial asset, especially money, which is lent on the condition that it is returned, usually with interest.
A mortgage is a legal agreement which uses housing or other property as security for the repayment of a loan. The loan may be for the purpose of purchasing the house or property, or for an unrelated purpose.
Loans and mortgages secured against property may also be described as encumbrances, being an owed amount which reduces a person’s equity (the extent of their ownership) in an asset.
How are loans and mortgages assessed under the income and assets tests?
The assessment of loans or mortgages for pension purposes depends on whether you are lending money to another person (such as a family member), or are receiving the loan amount. Loan amounts may also be lent to, or received from, other entities such as businesses, private trusts or private companies.
Loans made by a pensioner are assessed as financial assets, and are deemed. They may therefore affect your income support pension under the assets or income tests.
Loans received by a pensioner may be recognised as an encumbrance against their asset value. This will reduce the value of the asset under the assets test. However, as further explained below, it is generally necessary that there be a connection between the loan amount received, and the securing asset.
Loans and the Assets Test
How do loans or encumbrances affect the value of your assets?
If you lend money to family or friends, or to an organisation such as a private company, trust or business, the assessable value of the loan is the amount still owed to you.
Secured loans to you, such as a mortgage on an asset, are assessed in order to ensure that only the true worth of the asset to you is taken into account in the assessment.
Where there is a secured loan on a particular asset, the value of the asset is reduced by the value of the charge or encumbrance against it. For example, if you have taken out a $100,000 mortgage against a unit with a market value of $250,000, then the value of the asset will be assessed as $250,000 - $100,000 = $150,000.
How are secured loans on your principal home or other disregarded assets treated?
If a loan is secured against your principal home and is used to purchase another asset, the value of the outstanding loan cannot be deducted from the value of the purchased asset. This is because your principal home is an exempt asset under the assets test, and this exemption cannot be transferred to other assets which are assessable. Loans secured against other disregarded or exempt assets are treated the same way.
However, there are some instances where a mortgage against your principal home may affect the value of your assets. For example, if you take out a secured loan or mortgage against your principal home, and then lend this money to a private company, business or trust or to a person other than your partner, then the loan amount may be counted under the assets test. This is because under the assets test, loan amounts which remain unpaid are still treated as assets.
Other circumstances where encumbrances against formerly disregarded assets might affect the value of your assets include where you need to take out a mortgage against your former principal home for the purposes of paying an entry fee to a retirement village.
For more information about the assets test refer to Factsheet IS88 Assets Test Overview.
How are loans against real estate regarded?
Unless your rate of pension is calculated under the assets test the value of any real estate will not affect your pension. Real estate is any housing or land that you own separate to your principal home.
Examples of this include (among others):
- house, unit or flat (other than your home);
- vacant land;
- any part of your home that is used primarily for business purposes;
- time share property; and
- farm, market garden.
The market value of any real estate is counted as an asset for pension purposes under the assets test. The amount of any mortgage or loan secured on the property is deducted from the market value of the property.
If you receive rental income from a property or holiday home which you let for either the whole or part of the year, then interest on a mortgage used to purchase this real estate may be treated as an allowable deduction under the income test. An income tax return or proof of expenses must be produced for the deductions to be applied.
For more information refer to Factsheet IS103 Real Estate.
What are unsecured loans and how are they treated?
Unsecured loans are loans where nothing is offered to secure payment of the loan. This means that the lender is entirely dependent on the borrower’s capacity and willingness to repay. Where an unsecured loan is taken out to purchase an asset, the outstanding value of the unsecured loan or unregistered mortgage may be deducted from the asset's value. However, you must be able to provide some evidence that the loan was obtained specifically to purchase that particular asset. Evidence can include documents such as contracts or unregistered agreements.
Collateral security and excluded security loans
Collateral security for a loan is a “fall back” security provided in addition to the original security for a loan. Collateral security is regarded as an excluded security and cannot be deducted from the value of an asset.
An example of collateral security is where a person obtains a loan to purchase a block of land. As part of the loan, both the land and another asset, for example, a home unit, are offered as security. The value of the loan may only be deducted from the related land value. It cannot be deducted from the value of the unrelated home unit offered as collateral security.
Loans taken out to benefit someone else, apart from your partner, are also classified as excluded security loans. An example of this is where you provide your property as security for a mortgage to a third party (other than your partner). In this case, the outstanding balance of the loan cannot be deducted from the value of your property.
Apportioning a loan or encumbrance where two assets are used as security
If one mortgage (encumbrance) or loan is taken out against both a disregarded asset like a principal home, and an assessable asset, then the value of the loan is shared between the two assets. It is shared according to the values of each of the two assets. The formula used to apportion the loan and determine the value of the assessable asset is:
Value of loan x Value of assessable asset
Value of assets the loan is secured against
For example, you may have one loan secured against both your farm (an assessable asset) and your principal home (a disregarded asset). The total amount of the loan is $100,000. The value of the farm is $180,000 and the value of the principal home is $60,000.
The total combined value of the farm and principal home is:
$180,000 + $60,000 = $240,000. This is the value of assets that the loan is secured against.
Using our formula (i.e. $100,000 x $180,000) ÷ $240,000 = $75,000), the net asset value of the farm is $105,000 (i.e. $180,000 minus $75,000).
Loans and the income test
Under the income test, income includes money deemed to be earned from interest on loans.
Deeming is the method DVA uses to calculate income from your financial assets. Deeming assumes that any money you have invested in financial assets, such as loans you make to others, is earning a particular amount of income, regardless of the actual return.
Deeming is a simpler, fairer way to assess your income. Deeming rules will affect the payment of service pension, income support supplement and age pension.
Financial investments affected by deeming include, amongst others:
- Loans you make to other people including family and friends; and
- Loans you make to organisations, such as businesses, private trusts or private companies.
The deeming rate that is applied depends upon the amount of financial assets you have. The lower deeming rate of 1.75% applies up to what is called a deeming threshold. Above the threshold, a higher deeming rate of 3.25% applies. Deeming thresholds are different for singles and couples.
For more information refer to Factsheet IS89 Deeming and Financial Assets.
How are encumbered financial assets affected by deeming?
Financial assets, such as managed investments that are purchased using borrowed money, are assessed according to their gross investment value. This is the figure that is used for deeming purposes under the income test. This applies even when an undertaking is losing money, or where the repayments on the loan are greater than the return from the investment.
This can result in an asset having a different value under the assets test, as opposed to the income test through deeming. This is because for the purpose of calculating the value of a person’s assets for the assets test, the asset value is reduced by the amount of any encumbrance. However, under the income test, it is the gross investment value that is assessed.
For more information about deeming refer to Factsheet IS89 Deeming and Financial Assets.
Loans received as lump sum payments
Bona fide borrowings or loans obtained by a pensioner as a lump sum payment are not assessed as income for DVA purposes.
When do loans no longer exist for income support purposes?
A loan no longer exists for income support purposes in some of the following circumstances. When:
- it is repaid;
- the borrower is bankrupt;
- the lender forgives the loan, usually via a deed or gift of release; or
- the lender takes a loan contract to court to have it enforced and obtains either a court order to allow collection of the money or is unsuccessful and the amount is no longer owing.
Non performing and failed loans
The assessable asset value of a loan is the amount still owed to you but does not include any interest payable on the loan. This applies whether or not the loan is performing as it should be, to the terms of the loan agreement. The poor performance of a loan is insufficient grounds for exemption from assets test or from the deemed income rules.
Failed loans occur where you lend money which is then unable to be paid back. An example of this is when you lend money to a company which becomes bankrupt. Under the assets test, the amount of money still owed to you is the value of loan.
Where a failed loan exists, the loan can be:
- a disregarded asset if the hardship provisions are satisfied; or
- exempted from deemed income rules if the deeming exemption provisions are satisfied.
Whether you can be assisted by the hardship rules, or a deeming exemption, will depend on your particular circumstances. The hardship rules only apply to people whose pension is assessed under the assets test. They provide for certain assets, like failed loans, to be disregarded. This means that the rate of pension may be able to be recalculated at a higher rate. You must have started the necessary action to have either interest on the loan, or your capital, paid back.
If you have your rate of payment assessed under the income test, you may be able to have the loan exempted from deeming. A loan exempted from deeming is judged to be not receiving income.
For more information refer to Factsheet IS117 Financial hardship.
Legally irrecoverable loans
Legally irrecoverable loans are loans that no longer exist for income support purposes. Legally irrecoverable loans become disregarded assets under the assets test.
A loan is legally irrecoverable only if it has not been repaid in full, or in part, within the time frame and according to the terms agreed to under the loan agreement.
However, the fact that a person or organisation that owes you money is not able to repay the loan does not automatically mean that the loan is irrecoverable. If they are able to repay the loan, but are unwilling or refuse to do so, the loan is still legally recoverable and continues to be assessed under the assets test.
A loan can become legally irrecoverable when a lender applies to a court to have a loan agreement enforced and:
- the court decides that the amount is no longer owing; or
- a court order is obtained to allow collection of the money. In this case the loan becomes a debt because it must be repaid as a result of the court order, rather than because of the loan contract.
Forgiving a loan
A loan no longer exists for income support purposes when it has been forgiven. If you forgive a loan this means that there is no longer any expectation that the money will be repaid to you. Forgiving a loan may lead to the loan amount being regarded as a gift.
A gift is any money or property that you give away for which you do not receive adequate financial consideration. Gifts affect your pension because they either directly or indirectly reduce the assets available for your personal use.
The maximum amount you can give away, regardless of whether you are a single person or a couple, is $10,000 per year, or $30,000 over a rolling five year period. The rolling five year period is the current financial year plus the previous four financial years. If you give away more than $10,000 in a financial year, the amount in excess of $10,000 is counted as a financial asset for 5 years from the date that you gave it away. This excess amount will also be deemed to be earning income under the income test for the period of 5 years from the date that you gave the asset(s) away.
For more information refer to Factsheet IS92 Giving away income or assets.
Home equity conversion loans
A home equity conversion loan allows a homeowner to borrow against the equity in the home. It is an agreement under which the repayment of an amount is secured by a mortgage over the principal home.
The amount drawn down under a home equity conversion loan is not counted as income for pensioners. However, if you subsequently invest the money from the loan in:
- a financial asset, then the invested amount will be deemed to earn income under the deeming provisions; or
- a non financial asset, then any income actually earned, derived or received on that investment will be counted as income and the value of the asset itself may be counted as an asset.
For more information refer to Factsheet IS79 Home Equity Conversion Loans.
When you are granted an income support pension and periodically after that, you will be notified of your obligations. You will be required to tell us within 14 days (28 days if you live overseas or receive remote area allowance) of changes to your circumstances that might affect the rate of income support pension that you receive or your eligibility to receive that pension. These obligations apply equally to trustees.
The sorts of situations you would need to tell us about within 14 days (28 days if you live overseas or receive remote area allowance) are:
- your pension is reduced under the assets test and you increase your assets
- your pension is reduced under the income test or your pension is paid at the maximum rate and the increase in assets would put your total assets over the asset value limit.
Usually an overpayment of pension will not occur when you have met your obligations. However, sometimes even if you have met your obligations, an overpayment can occur because we have not been able to process the change before the next payday. We do our best to avoid this occurring, but it is not always possible. To provide you with your exact entitlement we are obliged to recover overpayments of pension when they do occur.
DVA General Enquiries
Metro Phone: 133 254 *
Regional Phone: 1800 555 254 *
DVA Website: www.dva.gov.au
Factsheet Website: www.dva.gov.au/factsheets
* Calls from mobile phones and pay phones may incur additional charges.
- IS79 Home Equity Conversion Loans
- IS87 Income Test Overview
- IS88 Assets Test Overview
- IS89 Deeming and Financial Assets
- IS92 Giving away income or assets
- IS103 Real Estate
- IS117 Financial hardship
The information contained in this Factsheet is general in nature and does not take into account individual circumstances. You should not make important decisions, such as those that affect your financial or lifestyle position on the basis of information contained in this Factsheet. Where you are required to lodge a written claim for a benefit, you must take full responsibility for your decisions prior to the written claim being determined. You should seek confirmation in writing of any oral advice you receive from DVA.