interest only loans

[leo]

Hi everyone

This is my first post...

I was wondering what are people's thoughts on getting an interest only loan for my first investment property? How long should the interest only period be?

I have no other properties as I still live at home and will be for a few more years.

Your thoughts would be appreciated.

Leo

 

[Rolf Latham]

Hi Leo

As long as possible and linked to an offset acct. 5 Years is the norm with some now going to 10 years.

Why ? So that you can shovel your spare cash into the offset acct, still save interest and then use the money in the offset acct for some private purpose like buying a home or car.

ta

rolf

 

[mitch]

Gday Leo,
you live at home with your parent/s ? Young and single ? with no real financial commitments , like kids ? .Id suggest P&I and build up your equity cause when you move into your own home you may wonder why so many people are sending you letters asking for money (bills).Take this low commitment time in your life to build up your equity by paying as much of the loan as quick as you can. MITCH

 

[Rolf Latham]

Hi Mitch

I agree with you, and ......... he should reduce his burden while he has not kids (let alone a wife :O) , but not with a P&I loan.

When he then buys his own place he will have a big fat non tax deductible mortgage because he has repaid principle on a tax deductible debt.

Redrawing on that mortgage is NOT deductible if he buys PPOR with the redraw, hence the IO mortgage with offset.

It allows you buid equity and have retained tax benefits

ta

rolf

 

[leo]

Thanks for your thoughts. I have been thinking along those points also. But I am not done yet...

I know, and like, how the offset account can be used to retain the tax deductibility of my loan (instead of redrawing).

And I know that I will gain equity due to the value of the property going up (hopefully!), and the time value of money decreasing the size of my debt in real terms.

But how will I recoup all the interest I have paid over those years I am paying interest only? Just through tax deductions?

Is there a possibility of an interest only loan that lets you pay extra (to go off the principal, a form of savings in a way)? What are the implications of this?

Or what if I was to pay principal and interest now, and then when I purchase my second property (probably a PPOR), I refinance so that I can still get the most out of my investment loan?

Sorry to ask so many questions at once!

Thanks

Leo

 

[mitch]

Redrawing on that mortgage is NOT deductible if he buys PPOR with the redraw, hence the IO mortgage with offset.

Gday Rolf,
thats a very good point and one l hadnt thought of, so thats a good way to have your equity and use it too
MITCH

 

[Kevmeister]

leo:

The use of the offset account is more of an accounting trick/taxation trick (ie. to keep the ATO happy) than any kind of black magic.

If you borrow say $100K as a P&I loan, the repayments will comprise a portion for interest and a portion to repay principal.

Let's say you get $20K ahead on your P&I repayments and your loan balance is now $70K. If you redraw the $20K from your P&I loan and say buy a PPOR the ATO will now deem that you only owe $70K on the IP, even though the actual balance of the loan is $90K. In other words, $20K of the loan is no longer tax-deductible to you.

But if you use an offset account linked to an IO loan, you get to have your cake and eat it too. The only downside is that IO loans have shorter durations than P&I loans, presumably because usually it is investors that use them.

But if you have an offset account linked to an IO loan and continue to make the same repayment that you would be if you had a P&I loan you will slowly build up the offset account, it will be saving you interest in the same manner that a P&I loan would, but you can redraw from the offset account at any time without having the ATO hassles mentioned above.

This is because the loan balance of the initial IO loan would still be at $100K - it hasn't reduced by one cent. You are receiving the benefit of the offset account without it affecting your loan balance.

 

[Les]

G'day Leo,

you said

But how will I recoup all the interest I have paid over those years I am paying interest only? Just through tax deductions?

You may not know that the usual P&I loan takes 75% of its period to pay off just HALF of what you owe. Over that time, you are also paying Interest on the outstanding balance. HOW were you ever going to recoup that??????

Yes, I know it wouldn't be quite as much as IO, BUT you will still be paying Interest, even with P&I. In fact, for the first five years there is VERY LITTLE DIFFERENCE between the Interest on a P&I vs an IO loan !!!!

Now, how about an alternate scenario:- Let's say you do as Rolf suggested, and pay what you WOULD have paid on a P&I loan. How would that help???

1. First off, you can "redraw" without penalty at any time !!!
2. Offset is FAR BETTER than sticking any savings in a Bank account (you DON'T pay Tax on the Interest) so stick any extra savings into the Offset as well.
3. After a year or three, you may well have a sizable sum sitting there that can be used INSTANTLY to use as a deposit on another IP (try getting a Bank to "release" the funds you've paid back on a P&I loan? Certainly NOT instant, if AT ALL !!!!!!
4. If you really, really, REALLY can't sleep at night owing all that money to the Bank, you can always withdraw it from Offset and PAY IT OFF your mortgage...... (hopefully, though, you'd have grown a little, thought a little, and decided that IO is really the way to go - but it's YOUR choice !!!!)

So, you get the best of BOTH worlds - you decide WHEN, and you have the choice of CHANGING YOUR MIND by going Offset. By going P&I, you allow the Bank to call the shots.

Your call......

Regards,

 

[leo]

Thanks again everyone for your thoughts. I do feel a lot more confident about taking out an interest only loan now.

Leo

 

[Pele]

Gday

I am still yet to buy a prop but i am reading as much as i can and thinking hard about everything. One thing that i only realised this week was that for the IO v P & I is what happens if you do a IO and interest rates rise. You better make sure you are not flying to close to the sun or it could be tears.

Pele.

 

[Rolf Latham]

Hi Pele

You can insure against rate rises by fixing an I/O loan from 1 to 10 years.

Ta

rolf

 

[D.T.]

The fixed rates for I/O loans are fairly high tho, from what I've seen so far. Hopefully Rolf will correct me here

Tho I guess the motion by the RBA this week to keep rates where they are for the 10th time in a row is good news.

 

[Bill.L]

Hi all

While I agree 100% with Rolf's financial assesment there are other factors that could sway people. It has to do with discipline. For some people having a large chunk of money sitting in an account is too much of a temptation and they just spend it especially if they get a new girlfriend/wife.
Whereas a P+I loan with extra payments withdraws the temptation.

bye

 

[Rolf Latham]

Hi DT BL

DT, rates at 6.19 for 5 years i/O on 250 k plus is pretty good. Beyond 5 years it gets exxy, your right !


BL, Yep 110 % right, but that is where the bankie or broker needs to extract the soft data to see if the borrower benefits from an I/O strategy. Someone with a 25 k card limit on 24900 is commonly a better bet with a P&I

Ta
rolf