Finance

[WebBoard]

From: Mike .


first IP again
From: [email protected]
Date: 20 Dec 2000
Time: 13:21:53

Hi - Im looking to get my 1st IP in adelaide approx 150k, living at home.

Question: Should I get a IO loan, or P/I loan to build equity, or split the loan part IO, part P/I loan?
<p>
I plan to purchase another IP in a year or 2. Will a I/O loan with offset be better? With an IO loan - say I save another 10k during the year can I pay off some principal with this in 1yrs time, and refinance to take another loan with the equity?
<p>
I have posted this question earlier and no one really answered thanks in advance.

 

[WebBoard]

Alston

Reply: 1
From: Mike .


Re: first IP again
From: Alston
Date: 20 Dec 2000
Time: 14:35:33

Sorry but I will give you two answers.

Answer number 1. Many people are uncomfortable with IO and never paying back the loan. This fear is actually unfounded because inflation, the increase in the value of the property and increases in rent actually reduce the (real) value of the loan over time. However, if you are really uncomfortable with this, go for P&I or split (there is value in being able to sleep at nights). Otherwise ...

Answer 2. Paying off the loan does not give you any extra equity. The money was yours to start with. If you pay, say $10k off the loan, all you have is a $10k smaller loan but $10k less cash. All you get is the interest on this amount (which you don't have to pay) which, depending on your tax rate and structure, is about 4% after tax. Given that inflation is about 2-3% this is not good. You also loose some flexibility because the amount is tied up in the loan.

Equity (profit) comes from growth in the value of the property (above what you paid for it, for all you 'buy at retail' people) and increases in rent. The better approach is to work out what the P&I payments would be, pay IO and save (bank) the difference. Any additional money should also be banked, ready for your next purchase.

Buy the way, congratulations on entering the game.

 

[WebBoard]

Anna

Reply: 1.1
From: Mike .


Re: first IP again
From: Anna
Date: 20 Dec 2000
Time: 15:34:07

I disagree with some of the response above.

If you have redraw on your loan account you will have the option of withdrawing this money when you require it as well as gaining better interest than you would get in a bank account. You could invest it at a higher interest however this might not suit you as you need to access this money in the short term. I also disagree in regards to the tax paid on the interest. If you pay money off your loan the interest you save is tax free. And it is compound interest.

You may find that your bank will allow you to pay extra off an interest only loan and this way yoiu can get the best of both worlds. Just make sure that they will let you redraw it at any time without penalty.

The banks usually define "equity" as being the difference between 80% of their valuation of your property and what you owe. So equity is created by purchasing at less than the banks valuation, growth in the value of your property and any amounts you might pay of the loan.

Best of luck : ) - Anna

 

[WebBoard]

Alston

Reply: 1.1.1
From: Mike .


Re: first IP again
From: Alston
Date: 20 Dec 2000
Time: 16:19:39

Anna

Its good to see this chestnut has sparked some discussion.

I think the key to this issue is that the property being purchased is an IP, not owner occupied. If the property was owner occupied then I would agree with all of your points, get your consumer debt down using whatever means possible.

In the case of an IP, the redrawing of additional funds off a loan whose purpose is for an IP becomes very messy from a tax perspective. The ATO does not recognise the interest on the redrawn amount as an expense unless the redrawn amount is for investment also, but it is very, very messy. If the redraw is for personal use it is a problem.

The interest saved on additional funds paid off an IP loan is not tax free. If the funds were not paid off the loan, the additional interest would be tax deductible as an expense. Thus the it is the after-tax interest expense that is avoided by paying additional funds off the loan.

In relation to the banks and equity, if you can pay a larger deposit because you have cash rather than a lower loan, the effect is the same. In fact, it has been my experience that the banks prefer to see a larger deposit rather than cross-security with another property.

 

[WebBoard]

Mia

Reply: 1.1.1.1
From: Mike .


Re: first IP again
From: Mia
Date: 20 Dec 2000
Time: 16:46:50

I actually spoke to my bank today about taking out a loan for my IP. They were extremely helpful, and offered me the folowing solution: Combine the value of both my Home and the IP and use 90% of that value as my borrowing capacity. Then take what I still owe on my home and subtract that from the borrowing capacity figure. That left me with a loan for 98% of the IP cost. I was extremely surprised to see it done this way. I can now continue to reduce my home loan as quickly as I can. Has anyone had experience with this before.

Also, as I already have my home loan as part of a Professionals Package, I pay absolutely no fees on this new loan. Now I just have to get it approved!

 

[WebBoard]

Sim

Reply: 1.1.1.1.1
From: Mike .


Re: first IP again
From: Sim'
Date: 20 Dec 2000
Time: 17:01:27

Just make sure that the loan for the IP is separate from the loan for the owner-occupied (or at least that the interest component is separate), otherwise you will have a tough time with the ATO.

Other than that... go for it !!

Sim'

 

[WebBoard]

Pierre

Reply: 1.1.1.1.1.1
From: Mike .


Re: first IP again
From: Pierre
Date: 20 Dec 2000
Time: 21:10:14

Be careful that the bank does not try to get hold of both properties under one mortgage. Tell your banker that you want to have two separate titles - one for each property. Refinance your existing home loan with a split loan. Use the second part of the split loan as the deposit + costs for the investment property, and then take out a separate loan on a separate title for the IP (borrowed to 80% or 90% - whatever you choose). DO NOT let the bank secure both properties with the one loan.

As you have a Proff. Choice packagae (assuming NAB), you don't pay additional fees or additional loan applications. If you are unsure of what I mean, either :

1. Read all the posts on this forum and in the archive - you will find the answers in more detail there or

2. Email me [email protected] and I will call you to discuss.


BTW, Who's your banker? Is it Angie at the NAB? Are you the Mia I know?

Pete Noake

 

[WebBoard]

Mia

Reply: 1.1.1.1.1.1.1
From: Mike .


Re: first IP again
From: Mia
Date: 21 Dec 2000
Time: 12:05:04

Hi Peter. Yep I am the Mia you know. The package is with Westpac. The way the bank described it, the IP would be seperate from the home with the home loan being left completely as it is. Of course I was just making a quick inquiry and haven't thrashed out all the details with the bank yet. I'll keep your advice in mind when I discuss it with them next.

 

[WebBoard]

Liam

Reply: 1.1.1.1.1.1.1.1
From: Mike .


Re: first IP again
From: Liam
Date: 20 Dec 2000
Time: 16:35:12

The way I see it you buy cheaper than retail, only finance ip's IO, slightly improve ip if it is older, then when you are ready you will have equity to purchase another ip without spending your own money.

If you choose to pay down the IO loan or put down a large deposit on top of all this you just get to buy more due to increased equity. These are all subject to your situation and preferences.

When investing in property it seems to me and I am learning very quick the more creative you are the more your wealth will grow. My opinion.

Happy Christmas

 

[WebBoard]

Dee

Reply: 1.1.1.1.1.1.1.1.1
From: Mike .


Re: first IP again
From: [email protected]
Date: 21 Dec 2000
Time: 00:09:23

Thanks for all the replies!! I understand the advantages of the IO loan but this will be my 1st property.

Jan in her books has reiterated how important it is to build equity. She suggested somewhere that if living at home or renting than the first IP may be better to do P/I to build an equity so that future IPs can be IO and can be borrowed against the equity.

If I borrow interest only, and I want to buy another property in 1-2yrs, I may have saved an extra 10k. Now the property value may have gone up a little say 10k, ie this is my equity. I'll need to put this 10k into the new property for a deposit??????

Will it be more efficient to do P/I on the 1st, and then I/O on later property investments or go I/O from the outset? If I go I/O from IP #1 then wont I hit a wall later down the track when trying to finance further IP? I may be wrong - please clarify.

thanks - Dee

 

[WebBoard]

Alston

Reply: 1.1.1.1.1.1.1.1.1.1
From: Mike .


Re: first IP again
From: Alston
Date: 21 Dec 2000
Time: 06:04:33

Lets look at two scenarios:

Scenario 1, the first property increases in value by $10k and you have paid an extra $10k off the loan. The result is that you have $20k of equity in the property to borrow against. Great

Scenario 2, the first property increases in value by $10k and you have saved $10k . The result is that you have $10k of equity in the property and $10k of cash, a total of $20k of equity (capital). Great. In fact, even better because the $10k of cash is just that, cash. It can be used as a deposit on your next property, it can be used to cover emergencies (both personal or investment related), to grab that bargain property, or to pay off the loan if interest rates rise and you want to keep the repayments down.

Paying extra off an IP (not consumer) loan does not give you any extra equity. The money was yours to start with, all you have done is reduced your cash asset and reduced your debt, the net effect is zero. Also the interest avoided is small in after tax terms. Wealth is not created by paying off investment debt. Historically, most wealth has been created by using other peoples money (OPM).

However, there is one caveat that should be considered. If you are not a good saver, then pay it off the loan, not for the purpose of increasing equity or reducing the debt, but for the purpose of forced savings. While cash is more flexible than a reduced IP debt, it is also easier to spend on 'doodads'.

I don't know where I read this (it may have been RK but I am not sure). Two boys are talking. One says "my dad says we are poor because we owe the bank $10,000." The other boy says "My dad says we are rich because we owe the bank $1,000,000."

I hope this helps.

 

[WebBoard]

Owen

Reply: 1.1.1.1.1.1.1.1.1.1.1
From: Mike .


Re: first IP again
From: Owen
Date: 21 Dec 2000
Time: 09:40:29

My dad says we are poor because we owe the bank $10,000." The other boy says "My dad says we are rich because we owe the bank $1,000,000."


I like this!!!! It's a bit like "Wish I had a $1million tax bill coz then I would have earned $2million"

 

[WebBoard]

Wins

Reply: 1.1.1.1.1.1.1.1.1.1.1.1
From: Mike .


Re: first IP again
From: Wins
Date: 21 Dec 2000
Time: 06:25:13

Have you considered using an I/O line of credit type loan? If used correctly, this can reduce your loan balance very quickly and also gives you the flexibility of being able to redraw up to the approved amount at any time (so good money management skills will need to be applied).

Also think about your property investment strategy when deciding which type of loan product to use. I think for negative gearing Alston made a good point about not putting your $10K saved money into the loan. This could perhaps be invested for high returns until required (for deposit on second property etc). But if your property is positively geared, you wouldn't be getting the tax concessions anyway so why not reduce the loan and increase income from the property?

Just my thoughts for the day. Any comments/corrections/criticism welcome....