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From: Mike .


Seeking Advice From Les, Andrew G, Crystal and any others who have been in my situation!
From: Craig
Date: 08 Nov 2000
Time: 13:35:35

I have saved a deposit of around $30,000, am currently renting, and have a gross income of $73,500.

I am 31, live in Sydney and am looking at buying my first IP, with the plan to buy as many as possible as fast as possible.

With my first investment loan, is it best to go P & I to build up equity to buy my second, or should I go IO from the word go?

Any advice on the best way to start would be very appreciated.
 
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Crystal

Reply: 1
From: Mike .


Re: Seeking Advice From Les, Andrew G, Crystal and any others who...
From: Crystal
Date: 08 Nov 2000
Time: 21:21:53

Hi Craig,

I was asking the forum the very same question about six months ago. I was in an almost identical financial situation, too. Go with P&I to build up equity....OR.....go with IO and add value to the property to increase the equity.

If you can buy below market value, with a lender who will lend on the valuation price....this creates equity...so an IO loan would leave you with the cashflow to buy your next IP. If you choose an IO loan, you can pay off the principal when/if you have the cash (this was my choice). With a P&I loan you MUST pay the principal and the interest. Hope this helps!

Crystal
 
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Caroline

Reply: 1.1
From: Mike .


Re: Seeking Advice From Les, Andrew G, Crystal and any others...
From: Caroline
Date: 09 Nov 2000
Time: 11:29:12

I've been thinking of the question of P&I vs IO myself recently in the case of investments. These are my current thoughts:

If your return on investment ie your IP is higher than the interest rate your paying on your loan - then those principal payments would earn you more if you channeled them into another investment earning you a similar ROI.

What do you think?
 
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Owen

Reply: 1.1.1
From: Mike .


Re: Seeking Advice From Les, Andrew G, Crystal and any others...
From: Owen
Date: 09 Nov 2000
Time: 13:27:38

Caroline,

You have a good way of looking at it but I think the point of I/O loans is more to do with maintaining your cash flow.

Regardless of the percentage return, as long as your costs are being covered by rent you can then use your additional cash for more investment. If you bought in a growth area then that cash may come from other earnings, if you bought in a high yield area then you have extra cash from that.

As someone once wrote on this forum ages ago, "if I pay $100 of the principal what have I got? $100 in equity". That's a pretty slow way to wealth.
 
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Gee Cee

Reply: 1.1.1.1
From: Mike .


Re: Seeking Advice From Les, Andrew G, Crystal and any others...
From: Gee Cee
Date: 09 Nov 2000
Time: 19:58:01

HI Ya's

Crystal & Owen I run along with your opinions.

I/O gives you the minimun amount of cost to hold the property which will hopefully be going up in value. If you went P&I that extra amount of $ each week/month will certainly chew at your cashflow.

If you want to pay some off the principal you could always put the extra aside and pay it back at re-financing.

Or perhaps set up a portion of the loan P&I (Split Loan) and bite at this when you have any spare cash above the normal payment required.

Myself I prefer to have the cash aside for expanding. Or perhaps picking up a bargain priced Gold Turbo like TW has.

Happy Investing - Gee Cee
 
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Pierre

Reply: 1.1.1.1.1
From: Mike .


Re: Seeking Advice From Les, Andrew G, Crystal and any others...
From: Pierre
Date: 09 Nov 2000
Time: 22:47:19

How the hell does she fit The Husband, two kids on car seats, and all their stuff (God! the whole corner of that restaurant was a mess!!) in a Porsche??

Must be one of the fancy imported stretch-limo models.
 
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Caroline

Reply: 1.1.1.1.1.1
From: Mike .


Re: Seeking Advice From Les, Andrew G, Crystal and any others...
From: Caroline
Date: 10 Nov 2000
Time: 03:40:41

Owen

I agree ROI is not the only measure of a good investment. Capital gains are important too but are much more subjective measure, especially when trying factor this growth into subsequent refinancing.

Cashflow from IO loans and your ability to refianance for extra equity attained by a capital gain are greatly affected by the current interest rate on those loans whether they be fixed or variable rate.

Therefore, the advantage of paying off principal and thus having greater equity (as opposed to using those funds for additional investments) is that your risk level is reduced by not being reliant on interest rate fluctuations. Reducing principal loan repayments as well as increasing equity also increases cashflow by interest expenses saved. Thus allowing these funds to be channeled elsewhere.

Therefore, the measurement of ROI and capital growth of an investment need to be weighed when determing whether to pay P&I or IO.
 
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Owen

Reply: 1.1.1.1.1.1.1
From: Mike .


Re: Seeking Advice From Les, Andrew G, Crystal and any others...
From: Owen
Date: 10 Nov 2000
Time: 09:04:16

Good points. None of the calculations used when analysing an IP can be taken in isolation. What you do can be determined buy the market situation forecasts, interest rate forecasts, capital gain forecasts, tenancy vacancy forecasts.

However, forecasts are just that. Some are certainly more reliable and predictable but it is still speculation. You are correct in saying that it is all about your own personal risk profile. How comfortable are you doing what you are doing. Careful management is needed to ensure you don't overextend yourself financially by leveraging every spare cent but as long as your costs are covered, you should be in a better situation than those heavily negatively geared. I believe I/O is the best way to achieve this in most cases.

Once the passive income from your portfolio is significant enough, it can be used to pay down some of your loans if you wish. Better than working to do it.
 
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Les

Reply: 1.1.1.1.1.1.1.1
From: Mike .


Re: Seeking Advice From Les, Andrew G, Crystal and any others...
From: Les
Date: 10 Nov 2000
Time: 18:03:05

G'day Owen, Caroline, et al,

Your quote, Owen:-

"As someone once wrote on this forum ages ago, if I pay $100 of the principal what have I got? $100 in equity. That's a pretty slow way to wealth."

And an important addendum is that the $100 is paid out of AFTER TAX income - so that could mean you are earning $200 to gain $100 in equity.

I am very much an advocate of IO - if you get real lucky and win a lottery, have a shares win, or other such, you "may" want to consider paying some off the principal - but don't forget to work out the "opportunity cost" of doing this.

Cashflow 101 provides some good lessons re "what is my money best spent on" - I know you'd agree with that one, Owen. Great day on Sunday.

Regards, Les
 
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Caroline

Reply: 1.1.1.1.1.1.1.1.1
From: Mike .


Re: Seeking Advice From Les, Andrew G, Crystal and any others...
From: Caroline
Date: 11 Nov 2000
Time: 05:58:48

Les You say that: And an important addendum is that the $100 is paid out of AFTER TAX income - so that could mean you are earning $200 to gain $100 in equity.

Even if you reinvest the money in other investments as opposed to paying off a loan - you'll always be doing this in after tax dollars. Income less expenses less tax on profits (assuming +ve) = money for reinvestment (no matter what the structure is ie company/trust or individual)
 
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Les

Reply: 1.1.1.1.1.1.1.1.1.1
From: Mike .


Re: Seeking Advice From Les, Andrew G, Crystal and any others...
From: Les
Date: 11 Nov 2000
Time: 06:35:43

G'day Caroline,

Of course, you're absolutely right with your comment:-

"Even if you reinvest the money in other investments as opposed to paying off a loan - you'll always be doing this in after tax dollars."

The point I was trying to make was that using After Tax dollars to pay down principal is 1. expensive, and 2. almost useless.

Far better, I think, to follow GeeCee's comment and park the funds in an Offset (or LOC?) account. That way you have the "effect" of having paid down the principal (less interest), while keeping the money available for another "deal of a lifetime".

In fact, your words said it - "Even if you REINVEST the money in other investments as opposed to PAYING OFF A LOAN ...." Right there is the point - use the AT dollars to re-invest, NOT to pay off a loan (unless you HAVE TO!!)

It's that old "opportunity cost" again.

And thanks for pointing that out - hope this helps to clarify things.

Regards, Les
 
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Caroline

Reply: 1.1.1.1.1.1.1.1.1.1.1
From: Mike .


Re: Seeking Advice From Les, Andrew G, Crystal and any others...
From: Caroline
Date: 11 Nov 2000
Time: 08:58:17

Les,

I agree that a LOC is a good alternative. (It would be great if banks would allow other investments other then IP to be financed this way) Just to play devils advocate, how would you feel if the interest rates went up as they have historically to say 13%? At what point is the cost of interest too much?

I just think that IO strategies make you heavily reliant on interest rate fluctutations. And whilst this is not a bad thing - the subsequent risks that come with this strategy also need to be factored into the equation.
 
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Les

Reply: 1.1.1.1.1.1.1.1.1.1.1.1
From: Mike .


Re: Seeking Advice From Les, Andrew G, Crystal and any others...
From: Les
Date: 11 Nov 2000
Time: 09:28:30

G'day Caroline,

Another good question :-

"Just to play devils advocate, how would you feel if the interest rates went up as they have historically to say 13%?"

Answer:- With IO Fixed, no problem. And if the sums worked when you bought the IP, they will continue to work. Other factors come into it, too (don't they always ;^) - like Capital Growth, rental return, etc. And, of course, the same scenario would apply to P&I too !!!

In the end it all comes down to "different strokes" - some will NEVER go IO, and some will NEVER go P&I for Investment Properties.

Regards, Les
 
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Caroline

Reply: 1.1.1.1.1.1.1.1.1.1.1.1.1
From: Mike .


Re: Seeking Advice From Les, Andrew G, Crystal and any others...
From: Caroline
Date: 11 Nov 2000
Time: 10:12:57

Les,

I appreciate the debate - not that I'm not agreeing with you - I'm just saying it's just another risk to factor in along with everything else. Every situation is different.

>>And, of course, the same scenario would apply to P&I too !!! >> Yes but less if you've been channeling some extra funds in. These comments need to be read with my replies to Owen as well. That is if the interest rate is high and assuming you're not fixed at a good rate there comes a point where paying principal off is not a bad idea - it does give you extra cashflow too

Regards, Caroline
 
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Les

Reply: 1.1.1.1.1.1.1.1.1.1.1.1.1.1
From: Mike .


Yes, but ......
From: Les
Date: 11 Nov 2000
Time: 17:16:17

G'day Caroline,

Re your comment:-

"... if the interest rate is high and assuming your not fixed at a good rate there comes a point where paying principal off is not a bad idea - it does give you extra cashflow too"

Yeah - have to agree (somewhat) where you are suddenly getting a 13% (riskfree) return on your money, as opposed to 8%.

I'm still more in favour of "having my cake and eating it too" - (as before), don't PAY it off the mortgage, INVEST it in LOC or Offset Account. Then if there's nothing better out there, it does the same job as a P&I loan - but if you NEED the extra cash, it's available, no questions asked.

Enjoyed the exchange too.

Regards, Les
 
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