Interest only FLAWS

Dear all

I am thinking of refinancing my loan to a different lender who is offering better rates and upon reviewing whether I should choose interest only loan vs principle +interest loan I really want to get some expert opinions from everyone.

I believe interest only loans are flawed. The reason is all the lenders only give you the option of monthly payment for interest only loans instead of choice of weekly payment on a P+I loan. Now, we all know the more frequent you repayment are, the less interest you will pay. So, the banks are not stupid in designing their interest only loan as MONTHLY ONLY!

You may think as your offset account increases in money, the interest payment comes down. This is true but I really think it can go down a lot quicker if you are repaying on a weekly rather than a monthly basis. And of course, in order to repay weekly, you have to choose normal P+I loan.

Now, I have two interest only loans and are now thinking of changing to P+I loan with he refinancing due to the above reason. I know some people will argue interest only is good for short term cash flow and good for negative gearing. But I really think as long as you have reasonable cash reserve, we should pay P+I because in the long run it will save you hundreds of thousands in interest due to the monthly frequency flaw. As with negative gearing, I don't think it needs any more comments how flawed negative gearing system is.

My strategy in my investment properties is to buy and hold on term. So I really think paying it P+I should be the right strategy going forward. Happy to hear what everyone thinks of my theory above and feedback is greatly appreciated.

Cheers :)
 
Dear all

I am thinking of refinancing my loan to a different lender who is offering better rates and upon reviewing whether I should choose interest only loan vs principle +interest loan I really want to get some expert opinions from everyone.

I believe interest only loans are flawed. The reason is all the lenders only give you the option of monthly payment for interest only loans instead of choice of weekly payment on a P+I loan. Now, we all know the more frequent you repayment are, the less interest you will pay. So, the banks are not stupid in designing their interest only loan as MONTHLY ONLY!

You may think as your offset account increases in money, the interest payment comes down. This is true but I really think it can go down a lot quicker if you are repaying on a weekly rather than a monthly basis. And of course, in order to repay weekly, you have to choose normal P+I loan.

Now, I have two interest only loans and are now thinking of changing to P+I loan with he refinancing due to the above reason. I know some people will argue interest only is good for short term cash flow and good for negative gearing. But I really think as long as you have reasonable cash reserve, we should pay P+I because in the long run it will save you hundreds of thousands in interest due to the monthly frequency flaw. As with negative gearing, I don't think it needs any more comments how flawed negative gearing system is.

My strategy in my investment properties is to buy and hold on term. So I really think paying it P+I should be the right strategy going forward. Happy to hear what everyone thinks of my theory above and feedback is greatly appreciated.

Cheers :)

I dont think you full graps the concept.

With all loans (with major lenders anyway) interest is charged daily and added monthly.

This is the case with Interest Only loans too.

Most loans also allow extra payments. So if you had an Interest Only loan you could pay it weekly. Each payment would result in a decrease in principal and then on the same day each month the interest would be added and the balance increase.

But because you are paying weekly you will be saving interest on interest.

But you should also consider the tax aspects. As if you have deductible and non deductible debt and you are paying PI or weekly payments (ie extra) off the deductible debt then this is decreasing your deductions and resulting in you paying more tax. If you are paying more tax then that means less cash to pay down that non deductible debt. You are therefore losing money - throwing money away in fact!
 
I forgot to add

Having ALL your available cash in offset on an IO loan means all your money is working daily due to interest being calculated daily.

Id suggest that a PI loan paid weekly, vs an IO loan paid montlhy with the same cash outlay as PI parked in the offset will produce the same if not poorer result long term.

One of the xcel peops can probably model it quite quickly

ta

rolf
 
Weekly payments with an offset account wouldn't make any difference to monthly payments with an offset. Your offset account does exactly the same thing.

Most loans are actually paid monthly. They just take the money out of your account on a weekly or fortnightly basis. When lenders calculate fortnightly repayments, they first calculate the monthly payment and divide it by two. You get ahead with fortnightly repayments because you make 26 payments a year, but the payments are based on a 24 schedule. You make an extra months payment every year.
 
Yep, what the smart accounting types here have already said. But I'll add a bit more...

For a lot of people P&I works better because it forces you to save. Its a lot harder to redraw from the paid down loan than it is to spend the cash sitting immediately accessible in the offset account. But, if you have savings discipline, the offset IO loan is actually a faster way to achieve full paydown. As pointed out above, interest is calculated daily and added monthly so the minute cash appears in your offset account it is reducing your interest bill for that month. Not so a P&I loan without an offset account.

Hope that makes sense. I know that some people quarantine their offset accounts and do standing regular transfers to them from their working cash account where incomes are paid into and bills paid out of. In effect, this is like a principle payment when the transfer occurs. You can do these as often as you like or ad hoc as required. And, the second the transfer occurs, your interest bill reduces.

Also, as also alluded to above, IP interest is tax deductible so an IO loan with an offset is the best approach to preserve flexibility. Should you decide to buy a PPOR and borrow to do so but already have money sitting in an offset account offsetting deductible IP interest, all it takes is the press of a single transfer button in your online banking and suddenly all that offset cash is now offsetting your non-deductible PPOR interest instead and "exposing" your IP IO loan to deductible interest. Its a lot harder if its paid down using P&I and needs a redraw.

Structure your accounts and savings approach to work for you. IO gives the maximum flexibility and tax effectiveness over the long term. But you need to set it up properly and understand the savings discipline required. If you want to achieve the same or better outcome as P&I then once its transferred to the offset account, consider it unavailable and quarantined. Don't raid it for the annual holiday or new car. If you lack the discipline to do this, then maybe P&I is the best approach.

Cheers,
Michael
 
Run it through excel. Compare P&I fortnightly, and paying the same amount into the offset on the same days.

Having said that, if you're more comfortable doing P&I, go for it.
 
Strategy

What if you pay what would normally be a P&I amount, into a loan set up as IO

Would you pay it down faster?

Or are you better with an offset?

What if you rent and have multiple IP's and no PPOR, what should your strategy be?

What if rather than putting that money into P&I or an offset you used it to pay down another IP, you then have additional capital growth potential in the mix?
 
If you are depositing money into a loan it won't matter if it is PI or IO. If the rate is the same it would be decreasing at the same rate.

if you have no PPOR you should consider that maybe you will one day want one. So set up a IO loan and build up excess cash into the offset. That way when you do buy a PPOR you will have a large cash deposit and will be paying less non deductible interest while maximising your tax deductions.
 
What if you pay what would normally be a P&I amount, into a loan set up as IO

Would you pay it down faster?

Or are you better with an offset?

What if you rent and have multiple IP's and no PPOR, what should your strategy be?

What if rather than putting that money into P&I or an offset you used it to pay down another IP, you then have additional capital growth potential in the mix?

As far as "repaying faster" goes, $1000/month into a P&I should produce the same results as $1000 into an IO with offset. The only difference is you can take the cash out of the offset whenever you like.

This is a big advantage as you can then use this cash for other things.

Edit: Beaten to the post by above!
 
As far as "repaying faster" goes, $1000/month into a P&I should produce the same results as $1000 into an IO with offset. The only difference is you can take the cash out of the offset whenever you like.

This is a big advantage as you can then use this cash for other things.

Edit: Beaten to the post by above!

The real difference is the tax treatment.

You could redraw extra repayments from a loan but this would create a tax nightmare if you used redrawn funds for private expenses.
 
Weekly payments with an offset account wouldn't make any difference to monthly payments with an offset. Your offset account does exactly the same thing.

Most loans are actually paid monthly. They just take the money out of your account on a weekly or fortnightly basis. When lenders calculate fortnightly repayments, they first calculate the monthly payment and divide it by two. You get ahead with fortnightly repayments because you make 26 payments a year, but the payments are based on a 24 schedule. You make an extra months payment every year.

Thanks everyone for your help and clarification. Yes, I agree if interest is being calculated daily, then an offset account on a IO loan makes no difference in terms of amount of interest you would pay compare to a P&I loan even if it pays weekly. I also get the Tax advantage of not offsetting deductible loan and only offset non-deductible loan to save interest.

However, one more thing I am trying to get my head around: as PT_Bear said, if you make fortnightly payments you will make 26 payments a year compare to only 24 payments if its paid monthly. So you make an extra month payment every year - doesn't this mean you are better off paying it fortnightly or weekly compare to monthly? Does it mean the amount of interest you are paying under these two system are the same. But you can pay off the loan quicker with a fortnightly/weekly payment cycle?:confused:
 
Thanks everyone for your help and clarification. Yes, I agree if interest is being calculated daily, then an offset account on a IO loan makes no difference in terms of amount of interest you would pay compare to a P&I loan even if it pays weekly. I also get the Tax advantage of not offsetting deductible loan and only offset non-deductible loan to save interest.

However, one more thing I am trying to get my head around: as PT_Bear said, if you make fortnightly payments you will make 26 payments a year compare to only 24 payments if its paid monthly. So you make an extra month payment every year - doesn't this mean you are better off paying it fortnightly or weekly compare to monthly? Does it mean the amount of interest you are paying under these two system are the same. But you can pay off the loan quicker with a fortnightly/weekly payment cycle?:confused:

Interest is calculated daily. So if you make a $1 payment on the 1st you will be saving 1 x 5%/365 per day in interest. If you wait 30 days to pay you would be accruing interest on interest.

So you should pay as quick as possible.

But you could not pay daily as to do this you would have to be paid from work daily. There is no point in being paid every 2 weeks and storing cash so you can pay each day, you would simply pay as much as possible on the day of your pay. (and later redraw from the offset to buy groceries at the last possible moment - buying each day so your money can stay in the offset longer saving you even more interest)
 
However, one more thing I am trying to get my head around: as PT_Bear said, if you make fortnightly payments you will make 26 payments a year compare to only 24 payments if its paid monthly. So you make an extra month payment every year - doesn't this mean you are better off paying it fortnightly or weekly compare to monthly? Does it mean the amount of interest you are paying under these two system are the same. But you can pay off the loan quicker with a fortnightly/weekly payment cycle?:confused:

If you have a PI loan and you are paying proper fornightly repayments( rather than bimonthly) you will save a stack of interest over PI monthly because you are pouring an 8 %extra repayment into the loan. So its not Rocket Science that you will pay the loan off much more quickly.

The real power here is the extra cash, NOT the period of the repayment. if you pay 8.4 % more each month, the outcome is somewhat similar to paying fortnightly.

You may be getting confused looking to compare things that should not be.

Proper IO with offset AND A PREDICTIVE budget as to what should be in the offset account at the end of each month is just as powerful, but has much greater flexibility.

As alluded to by Fence and others............ flexibility comes with the need for responseability, and for some, accelerate PI is the only real option until they can see the huge benefits of a debt reduction plan unfolding.

ts
rolf
 
You credit guru's make me feel so guilty about my loans - I have started to get more organised with my loans of late, you guys provide the right considerations for the average punter.

Thanks, Ivan
 
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