Faster investing- Interest only for your first home?

Shonnie

Shonnie

Me and my partner attended a seminar by Jason Whitton, and during it we were told that for our first home, we should get an Interest only loan because it means that you have access to your equity all the time, and it will allow us to invest much faster.

I thought this was kind of weird because there are no tax breaks on the property that you will be living in- so your never paying off your own home.

I asked the companies financial advisor about it, and she said that you get an interest only loan - say the repayments are $1000 p/m, but you pay $1200 p/m which is what the P & I repayments would be. So your putting more money into this interest only loan, so you really are building equity and that way you could invest with it much quicker.

I am still not sure I understand this- can anyone else see the point in doing this? Lisa (the advisor) says that when you pay P & I you are giving your equity to the bank, and then it can be hard to get it back when you need it.

I need some more information before I decide to get this type of loan for my first home, does anyone know an experienced property/financial advisor I could chat to about it?

Or does anyone have any good opinions on this? :) Thanks!
 
Guys running seminars can only get dollars in their pockets by telling you that there is a smarter way of doing a simple thing. I have serious doubts.

Just do it the simple way and pay it off P&I (lowest int rate?). Buying a home cannot possibly launch you on the road to prosperity next year. In truth it is more likely to impoverish you. Some years down the track you can use the equity in your home to fund a commercial venture, but you will have just a little more equity if you have been paying down principal.

Not being a rocket scientist I am a strong believer in KISS.
 
I don't see a point in doing this.

If you pay extra into an IO loan, you generally don't reduce the amount owing by a single cent. You only build up a buffer where you can go without paying interest for a while. Personally, I'd rather keep the money rather than donate it to the bank interest free.

For a PPOR, I would prefer to pay down the loan myself (probably with an offset rather than just pay down- it gives me more flexibility). Then if I needed a deposit for an IP, I have equity ready to go.

Then I would use IO on the IP, and continue to pay down PPOR.

NOT advice- just what I would be doing.
 
Aceyducey said:
When are you guys going to start running seminars?
Click to expand...
As soon as Neil Jenman starts to flag me, I might have a hope of getting customers :D

Like Jason Whitton who was mentioned in the first post of this thread.

But then, I could also get slammed bu NJ for selling subs.
 
Hi Shonnie,

They only thing going through my mind as to why they suggest what you have mentioned is this:

Lets assume you take out a loan for $200,000 at 7% interest rate.

1st Scenario you take out a P & I loan over 30years - the P & I repayments would be $1330.60 per month. So after 3 years of doing this (making the minimum P & I payments) the loan balance would be $193,453. Because you have only made the minimum payment there would be no-redraw. Sounds like they are saying no equity. If you wanted to go back up to $200,000 you would have to apply to the bank for a loan increase - which they may or may not give to you depending on whether your circumstances have changed since you originally took out the loan. This could by why she is saying it is hard to get your equity back when you need it.

2nd Scenario you take out the same loan but as an Interest Only Loan - the interest only payments on the same loan would be $1,166.67 per month. So this is all the bank expects you to pay for the interest only term, in 3 years time the bank expects your loan to still be at $200,000 - however if you make repayments of $1330.60 then you will be making extra payments. So in 3 years time you mortgage balance would be the same ($193,453) - but because the bank still expects you mortgage to be at $200,000 - you would have redraw of $6,547. This being redraw you should be able to access a heck of a lot easier than applying for an increase in Scenario 1.

Geoff said "If you pay extra into an IO loan, you generally don't reduce the amount owing by a single cent" - Is that correct????? Anybody else's opinion???

Personally I think the way to go is have an IO loan on your home loan and attach the offset account. This way you don't directly reduce your loan principal (handy if you ever want to keep it as a rental down the track) and any extra cash that you have goes into the offset account and serves the same purpose in minimising the interest cost as what it does to pay it straight off the loan.

Sounds simple enough to me.

If you want to optimise the tax benefits then I would go one extra step - instead of withdrawing the funds from the offset account for the deposit on the IP - I would pay this full amount off the PPOR interest only loan - and then create a split loan for the same amount and redraw the funds back out again to use for the deposit. This way you have lowered your PPOR debt, and get to claim the interest on the money you borrowed from the split for the deposit on the IP.

It is still simple - some numbers may help though:

So we have an IO loan for $200,000 which we attach an offset account. Lets say that after 3 years we have been able to accumulate $40,000 in the offset account. So now we still have a mortgage of $200,000 - but since we have $40,000 in the offset account we only pay interest on the $160,000 - so it is like having a net mortgage of $160,000.

I think this is the better way because at this point if we want to move out of the property (keep it as a rental) and buy another PPOR - we take the $40,000 and use it as a deposit on the PPOR. If we take the $40,000 out of the offset - this means the net mortgage will go back up to $200,000 and we will be paying interest on the $200,000 - since we have not altered the principal on the loan we should be able to claim all of the interest against the rent.

But now lets assume we want to keep living in the original PPOR and buy an IP. If we take the deposit for the IP out of the offset then we are not maximising our tax deductions. So at the point when we are ready to buy (or a month before). We take the $40,000 in the offset account and pay it off the principal on the IO loan. Now we have an IO mortgage of $160,000 and nothing in the offset. We then go back to the bank and say that we want to create a split and borrow an extra $40,000. So instead of having a PPOR mortgage of $200K - we now have 2 loans - a PPOR of $160,000 and $40,000 borrowed as a deposit for the IP. As the $40,000 has been borrowed for the purposes of buying the IP the interest should be tax deductable. So by doing this we have turned undeductable debt into deductable debt.

I hope that doesn't sound too complicated. This approach has been covered previously on the forum and if you speak to most good brokers they will recommend the same thing.

If you are just starting out - I would go with an IO loan with a 100% offset attached. This will give you more flexibility down the track if you decide to keep it as a rental.

Obviously this is not personal advice and you should contact your financial advisors before acting on any of it - but hopefully it gives you a better understanding which is what the forum is all about.

Geez that was long winded. Could be something to do with why I tend to lurk more than post. :)

Cheers
 
Looking at the loan amortisation graph, if you just pay the minimum payments on a P&I loan the principle component is negligible (as per Willy1111's example it's only 3% of the loan) anyway. i.e. even if you could redraw that amount, it's so small it's unlikely to get you another property.

If you're able to save enough so that the first couple of years' extra payments are enough to make up a deposit on an IP, just set up a LOC or offset account. Why mess with IO's for your PPOR? I just don't see the advantage.
Alex
 
Hiya

(edit - just noticed that what I said is what willly already said up further)

IO for PPOR is recommended in many cases for 2 main reasons.

1. It wont be your PPOR forever, and many people convert the PPOR into an IP say 5 or 10 years down the track. If you have reduced the debt you have a double issue. One is that that you now need to make a non deductible loan on the old PPOR to raise equity and costs for the new place, and 2, you are likley payng income tax on the rent received.

Easy soln, Use an IO loan with 100 % offset acct, save any debt redn in the offset and when you move, use the money in the offset for deposit and costs -Voila.

2. Risk Management. Keep your money, your money, why decrease your cashflow, yes its only a few extra bucks, and some would argue you build equity more quickly. Those with a sanity factor in their calcs quickly see that equity growth, through capital gain makes the $, not the paying the loan off.

ta
rolf
 
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I agree...

...with Rolf!

It depends on your circumstances, but our current PPOR is IO and we do intend to convert it to an IP in a year or two, so it makes no sense to pay additional principal to the bank while reducing our tax benefit once its an IP.

By paying off your PPOR, you are reducing the interest you're paying, so in fact you're effectively earning 7.5% after tax (because you dont have to pay tax on it again) on your money.

But if you think you can earn more than 7.5% after tax elsewhere (probably a pre-tax rate of 12%) then you're better directing the principal there, growing it for a while and then paying tax on it to pay it off your PPOR. It really depends on where your money is going to give you your best return.

In defence of the advice you were given, if you have a $200, 000 loan and you looked at the example given above, you would have around $6500 in equity after three years. But if you assume a modest 5% annual growth, you'd have $31, 000 in equity from CG. So really, most of your equity is going to come from capital growth, not in your principal repayments. Maybe you should take that extra $200 per month and invest it in the share market to learn how it works, or courses/books on getting rich.

Just my thoughts...

Tubs
 
Agree with everything here.

I try to set up all mortgages as IO with a 100% offset. For me, this is the most flexible option, it allows me to switch from PPOR to IP with no effort.

The problem you run in to is that the bank hasnt locked in anything to the principal so at any time you can walk away with your offsets. This has an effect on your LVR so they won't keep giving them to you. Having said that the CG usually takes care of this, but leaves you then with a serviceability issue.

The other advantage I've found is that with several loans like this it puts me in a great position to make cash offers on subsequent properties as you can use all the offset cash. I have made cash offers like this then organise the finance during settlement knowing that at worst case I can settle with cash if necessary.

This is also a negative for some people because the money in the offsets is pretty easy to get at. You have to be sure that its only used for the powers of good, not evil :)

Its amazing how many people dont understand IO loans, I've lost count of the amount of times ive explained to people that if you pay your 'principal' part into an offset then end result is exactly the same.


Bruce
 
One bit I want to clarify:
e.g. I have a $200k loan IO on my PPOR with offset. After a year, say, I pay the interest and have $20k in the offset. All interest on the (effective) $180k is not deductible.

Then I use that $20k as a deposit for an IP. Is the interest on that $20k (given that it's part of the PPOR loan) tax deductible? How do you pass the nexus (usage) test when the offset and loan accounts are separate? Would the ATO view your usage of the offset account (which increases your interest on the loan account) as sufficient to make the 'extra' interest on the loan account deductible against the new IP?

Compare this to if I had a IO (or P&I) with a LOC. After a year I have $20k available to redraw. If I use that to buy a IP, then for the PPOR loan $180k is non-deductible and $20k is deductible.

I can certainly see how an offset is more flexible but how does the tax part work?
Alex
 
Hiya ALex

What you do then is you SPLIT the ppor loan into a 180 IO non ded and a 20 k ded, pay the 20 k off the 20 k split and redraw it, and then invest the 20 k.

This is the model adopted quite succesfully by Uncle Steve and many others in a debt recycle strategy

ta
rolf
 
Thanks heaps guys! It makes SO much more sense to me now, and from what I've gather I definetely need to find a good financial advisor in Melbourne.. any recommendations?

Me and my boyfriend had a chat to a mortgage broker from Aussie and he just disregarded our investment plans and said no no forget all that go and get a standard P & I from Commonwealth..

It's great to talk to some really educated property ppl! :)

I'm planning to leave uni next year to work fulltime and hopefully have between 1-3 investment properties as well as our PPOR by the end of next year.. is that possible using this method? I think it is!

Thanks so much guys :) when I go to my property workshop in August I'll have a much better idea about what I'm doing..
 
Hi All

I can tell the Aussie Adviser doesnt do his own dirty work in following up loans once lodged, otherwise he would not be recommending CBA at this point.

Once again they are back on my black list because its an organisation that cares only about itself, and the only reason the broker side of the business hasnt imploded is because some clients insist on the brand.

I can not even begin to decribe the "could not care less attitude" which is re-inforced by systemic problems like setting service levels that have no relevance to the industry KPI's, and then be happy that they achieve them.

ta
rolf
 
Shonnie said:
Thanks heaps guys! It makes SO much more sense to me now, and from what I've gather I definetely need to find a good financial advisor in Melbourne.. any recommendations?
Click to expand...

Shonnie,

I'm not sure its a financial adviser you need. While in theory this would seem right. I went down this path and gave up in the end. Too many financial advisers have a vested interest in the 'plan' they pitch. They generally dont make any money out of direct property investments, so funnily enough they tend not to get recommended.

Of course this is a gross generalisation, and I'm sure (in fact I know) there are exceptions.

It seems from your message that you've already decided on your investment vehicle (in the short term) as being property, and in my experience you're not going to have much diversity in your plan in the early days.

I'd suggest what you need is a PI savvy Mortgage broker. I know my mortgage broker has been invaluable in offering creative solutions given that I already knew what I wanted to achieve. Perhaps you don't even need to look outside this thread to find one?

If a broker is suggesting a 'Mum and Dad' P&I loan as the only option then in all likelyhood they aren't the right one for you (thats not to say that this might be the right product in your circumstance).

All the best.

Bruce
 
Someone has recommended a good financial advisor in Melbourne who invests in property, so I'm going to have a chat with her soon and see what she has to say.

I sent the big post that Geoff wrote to my dad, going "see! see! how about this.."

He sent back a breakdown of what Geoff said, and this golden rule :D

..........ALL NON DEDUCTIBLE DEBT SHOULD BE REDUCED OR ELIMINATED
ASAP............

I'm like hmmm, maybe it should because it is considered to be 'bad debt', but considering I'm still young I figure having heaps of debt isn't really an issue coz I can just scratch it out and start again when I'm 30 if need be..

but anyways, he wrote these comments (all in uppercase), and he seems to have a different theory on how to do it..
I guess no one can say which one is better or worse, but coz everyone on here is a property investor they obviously have a different opinion to my dad (who doesn't invest).

So I'm just posing another question to you...
Considering that mine and my boyfriends combined income next year will be around $70,000 (before tax), do you think my dad's idea is better?

Read on to see his plans...

All his comments are in uppercase and quoting boxes.

Personally I think the way to go is have an IO loan on your home loan and
attach the offset account.
WHAT ABOUT THE INTEREST RATE ON THE OFFSETACCOUNT COMPARED WITH THE LOAN ACCOUNT?
Click to expand...
This way you don't directly reduce your loan principal (handy if you ever want to keep it as a rental down the track) and any extra cash that you have goes into the offset account and
serves the same purpose in minimising the interest cost as what it does to
pay it straight off the loan.
NOT EXACTLY THE INTEREST IS GREATER ON THE
LOAN. YOU WOULD "SAVE MORE" IN INTEREST BY REDUCING THE PRINCIPAL THAN
SAVING IN AN OFFSET ACCOUNT.
Click to expand...
Sounds simple enough to me.

If you want to optimise the tax benefits then I would go one extra step -
instead of withdrawing the funds from the offset account for the deposit on
the IP - I would pay this full amount off the PPOR interest only loan THE
GAIN HERE WILL BE INTEREST RATE DIFFERENCES
Click to expand...
- and then create a split loan
(MORE FEES HERE)
Click to expand...
for the same amount and redraw the funds back out again to
use for the deposit. This way you have lowered your PPOR debt, and get to
claim the interest on the money you borrowed from the split for the deposit
on the IP.

It is still simple - some numbers may help though:

So we have an IO loan for $200,000 which we attach an offset account. Lets
say that after 3 years we have been able to accumulate $40,000 in the offset
account. So now we still have a mortgage of $200,000 - but since we have
$40,000
(WHERE DOES THIS MONEY COME FROM ....$40000 @5% IS NOT AS GOOD AS
$40000@ 7% )
Click to expand...
in the offset account we only pay interest on the $160,000 - so
it is like having a net mortgage of $160,000.
.
....THAT MEANS AS WELL AS LIVING AND MEETING YOU NEEDS YOU CAN SAVE $1200 A
MONTH....WHICH MEANS YOU ARE EARNING A GOOD INCOME ...BEST OWN ANOTHER IO
PROPERTY..OR DIVERSIFY INTO SHARES OR .....SAVE THE TAX BY INCREASING
SUPERANNUATION CONTRIBUTIONS. TRY REPLACING $40000 WITH $6547 AND ITS NOT AS
ATTRACTIVE!!
Click to expand...

I think this is the better way because at this point if we want to move out
of the property (keep it as a rental) and buy another PPOR - we take the
$40,000 and use it as a deposit on the PPOR. If we take the $40,000 out of
the offset - this means the net mortgage will go back up to $200,000 and we
will be paying interest on the $200,000 - since we have not altered the
principal on the loan we should be able to claim all of the interest against
the rent.
IT'S THE SAME $40,000 YOU PUT IN .....THE ONLY SAVING IS THE INTEREST
BETWEEN SAVINGS AND LOAN AND YOU WOULD BE LOSING 2%PA IN THE OFFSET ACCOUNT.
Click to expand...

But now lets assume we want to keep living in the original PPOR and buy an
IP. If we take the deposit for the IP out of the offset then we are not
maximising our tax deductions. So at the point when we are ready to buy (or
a month before). We take the $40,000 in the offset account and pay it off
the principal on the IO loan. Now we have an IO mortgage of $160,000 and
nothing in the offset. We then go back to the bank and say that we want to
create a split and borrow an extra $40,000. So instead of having a PPOR
mortgage of $200K - we now have 2 loans - a PPOR of $160,000 and $40,000
borrowed as a deposit for the IP. As the $40,000 has been borrowed for the
purposes of buying the IP the interest should be tax deductible. So by doing
this we have turned undeductable debt into deductible debt.
THEN A THIRD
LOAN TO COMPLETE THE PURCHASE...MORE FEES
Click to expand...
....THIS HAS RISKS ATTACHED YOU CAN HIDE YOUR PERSONAL MORTGAGE ...BUT
DANGER FROM THE TAX MAN LURKS.... YOU ARE STILL USING THE SAME $40000.
SOUNDS LIKE A LOT OF BANK FEES AND FIDDLING........ YOU CAN ACHIEVE THE SAME
RESULT BY PAYING DOWN THE IO LOAN OVER YOUR PPOR (NOT DEDUCTIBLE INTEREST)
THEN USE THE EQUITY 40000 TO GET A 100% LOAN OVER THE INVESTMENT PROPERTY
THE LOAN OVER THE IP IS SECURED OVER BOTH PROPERTIES AND IT WOULD BE
AFFORDABLE AT THE INCOME LEVEL AS DESCRIBED.
Click to expand...



Annnd thats all.. Right now I'm kind of confused looking at all the numbers, but I think dad is saying there is no way I can save up $40,000, it would more likely be $6,000.. But thats crap coz I really want to buy my first investment next year..

Any response?

Thanks! :)
 
Hiya

There is some sage advice in what your dad says.

Some of it sounds though like he is operating with data that dosnt quite fit right now.

Questions on the % rate of the offset acct, and a focus on fees suggest that his general advice is ok, but for specifics, you may want to seek out someone that has crossed the minefield of today's war. not the last generation. The mines may have moved.


Finally, seek your general advice from who you wish, but best to seek specific advice from someone that IS AT where you want to be.

ta
rolf
 
Shonnie, while I'm all for structuring loans to maximise deductions and maximise money available for borrowing, I still think the best way to invest is with old fashioned savings.

I think that sometimes we believe there's some financial magic that will fund all our investments, but in the end, debt is still debt and the bigger equity (either cash or capital growth) cushion the better.

Other than analysing loan structures (very important) you might also want to look at your savings ratio. How much of your net income are you saving? If you're young with no kids, you should be able to save 30 - 50% of your net.

As for listening to your dad, I agree with Rolf. It sounds like good advice, but if your dad isn't an investor, then his advice may not be applicable to the real world. The most dangerous advice is advice that sounds good but has never been tested (even worse, out of date).
Alex
 
Shonnie,

You said below,

===Considering that mine and my boyfriends combined income next year will be around $70,000 (before tax)===



Just interested in a very general break down of expenses with your combined (pick one of the 3) yearly/weekly/fortnightly income figure.

Where will this cash go ?

Food
BTW you guys living at home or renting together.
Cloths
Credit cards
Car
Petrol


As a lurker, i'm interested in a general breakdown on where the cash is going. I feel, that you should be working out above expenses first and then see what you have left over to use towards investing.

Saving towards that $40,000 in the next 3 years or less. I work it out at $256 bucks per week out of your general pay packet per week to save $40,000 in 3 years ?

I'm just a general lurker on this great forum & looking to learn.

Geoff
 
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