Benefits of interest only loans

[Christie Lee]

Just wondering if I should take out an interest only loan this time. What are the advantages and disadvantages of IO?

What happens when all the interest is paid off? Do you then start paying the principle off?

TIA,

Christie

 

[super_sam]

Advantages:
Lower payments = improved cashflow = improved servicabilty = more investments
CG should build up far quicker than equity obtained through paying off principal

Disadvantages:
Dont pay off any principal
Lots of lenders only do 5 year IO loans so may need to refinance after this period. Not a problem IMO but others may disagree

 

[The Y-man]

What happens when all the interest is paid off? Do you then start paying the principle off?

The loan never gets paid off. You die triumphantly in debt.... and leave other people to sort out the mess for you

Cheers,

The Y-man

 

[Rolf Latham]

Rolf L Rule One

If properly set up, IO loans have no disadvantages for a disciplined borrower over a PI loan.

RolfL Rule Two

If in doubt, refer to rule one

ta
rolf

 

[ILoveProperty]

What happens when all the interest is paid off? Do you then start paying the principle off?

The interest is never all paid off. It accrues daily and is paid monthly - I think.

So, for the term of the IO loan (typically 5 years?) you pay interest monthly (or maybe some other frequency). The principle sits there. At the end of the IO loan you can try to continue it as an IO loan for another term, or convert to P&I.

If you mean, what do you do with any extra money above paying the interest, it can go to a redraw facility or offset account where the interest calculated is then for the principle minus the redraw/offset balance.

Something like that...

 

[Christie Lee]

Thanks guys. The reason I don't like the idea of IO only loans is because in 30 years time I will still have a big debt when if I just paid a little bit more from the start it would all be paid off. I know that in 30 years time the properties should be worth 6 times what they are now and that debt would seem not as bad then, but it's still debt that could have been paid off. Is that silly?

 

[Rolf Latham]

Hiya CL

Not silly, just personal.

View the fact you can use the deemed principal repyment as paying the interest on another ip,

To use your figures, 6 times growth, sell the other IP at 30 years and I suspect you will be way ahead

ta
rolf

 

[Mofra]

Thanks guys. The reason I don't like the idea of IO only loans is because in 30 years time I will still have a big debt when if I just paid a little bit more from the start it would all be paid off. I know that in 30 years time the properties should be worth 6 times what they are now and that debt would seem not as bad then, but it's still debt that could have been paid off. Is that silly?

If you hold multiple properties, you would utilise I/O repays on the Inv. portion of your debt, putting all the extra repayments into your non-deductable debt to recycle your debt into tax-friendly loans faster.

Horses for courses - given the average timeframe for mortgages is 4.2 years in Australia the 5 yr I/O period is not normally an issue for a variety of investers anyway.

 

[anrke]

Hi Rolf,

How does one work out what level of investment returns you need to be achieving on money that would otherwise have been paying off the principle on a loan?

I'd be interested in seeing an example with simple figures, say 200k loan at 8% after 30 years IO vs P&I.

If another thread has gone through this I'm happy to read. Whilst I understand the concept of IO and P&I, particular to maximise taxable debt, I've never really considered what you need to achieve with the princple payments, if they aren't servicing that loan, to make it a profitable decision.

Perhaps it's just something which cannot easily be explained with an example as many variables such as tax come into play.

Cheers
anrke

 

[geoffw]

There may be problems if you change circumstances.

If you have had stable employment, and then go into business (for example), the lender may require two or three years of business returns before allowing a loan to be renewed as IO.

If you have not had this, then you may have to revert to P&I.

 

[Jocker10]

Not wanting to hi jack this thread, but I wonder why lenders would care if the loan is PI or IO ?

I would have thought, the lenders are in the business of lending, so the more they lend the more interest income they earn.

Why would they want to reduce the amount lent thru PI?

Cheers Jocker 10

 

[redsquash]

Thanks guys. The reason I don't like the idea of IO only loans is because in 30 years time I will still have a big debt when if I just paid a little bit more from the start it would all be paid off. I know that in 30 years time the properties should be worth 6 times what they are now and that debt would seem not as bad then, but it's still debt that could have been paid off. Is that silly?

the debt is easier to repay as your earnings in your current postilion , in 30 years time will be much higher.
Or to look into the past, what would a person in your job have received 30 years ago. I think I may have been earning 125 dollars a week but the same position is now about $825 dollars a week

 

[GoAnna!]

In the 1980's my parents were paying $20 per month for a loan for a 4 bedroom period home in Canterbury. Inflation can be very kind to loans.

When I first began investing interest only loans were the hardest concept for me to grasp.

Why not pay P&I when it doesn't seem that much more than IO and actually pay the debt off? It made no sense at all to me.

Now my thoughts are:

If you have extra money and you have PPOR debt and you want tp pay down debt then put any extra money off that debt not your ips.

If you borrow say 1 mil on interest only at 7.56% it would cost you $6,300 per month and on P&I $7,034. So in this example there is a difference of around $700 per month which might might the differnce between being able to comfortably afford to hold onto thia property or not or being able to invest in further properties or shares. $700 is a lot to tie up each month.

If you don't have a PPOR and have entra funds then it allows you far greater flexability if instead of paying the money off the loan directly you place it in a 100% offset account. This has the same effect on the interest as paying off the loan directly. You are able to redraw it at any time for any purpose. To maxmise this effect you could place your whole salary in this account and reduce your interest payments further.

The main game with holding growth assets is to hold as many as you can because 10% growth on say 100K is $10K and on 1mil is $100K. So that extra $700 per month might allow you borrow another $100K and therefore $10K more growth per year.

Of course all of the above is personal choice and each of us has to sleep at night. Me personally, I have trouble sleeping at night f I have unspent equity.

 

[Christie Lee]

Thanks everyone. I am definately going to ask about an IO loan this time round.

GoAnna! You post in particular was helpful. So if a property is going to cost me $100 per week on P&I or $50 per week on IO, if I do the IO then I can put that $50 into our PPOR or another investment property. If I am able to have more IP's by doing IO loans then I am going to have the benefit of more capital gains. I am starting to feel the same about unspent equity. I spent all day yesterday looking at houses on the net and talking to real estate agents. I can't wait for the day when we actually own enough properties to have to keep a list.

 

[Simon]

Thanks guys. The reason I don't like the idea of IO only loans is because in 30 years time I will still have a big debt when if I just paid a little bit more from the start it would all be paid off. I know that in 30 years time the properties should be worth 6 times what they are now and that debt would seem not as bad then, but it's still debt that could have been paid off. Is that silly?

30 years ago my parents bought a Sydney waterfront home for $42K. Do you think they would lose a seconds sleep if they had gone IO on this property now worth $2M? (Unfortunately they never kept it ...)

Inflation is your friend.

Don't let IO worry you - as long as you invest the amount that would have gone into the Principal repayment you WILL be better off in 30 years.

If you wish to buy 1 property only for the rest of your life then go P&I. If you want more than 1 IO will get you there faster.

This is a common fear that we all faced when we first started. Get past it as soon as you can if you choose to get into the real investment world.