Loan Question

[Anonymous]

From: Anonymous


If I take out a $400,000 loan for 2 properties. 7.5 % for 10 years, total interest payable is $300,000 after the 10 years. After the 10 years of paying the interest I then need to then pay of the principle ($400,000. Is that done in a lump sum or how is it worked out?

But if I take out a principle and interest loan ($400,000) 10 years I only end up paying $169,768 in interest and the principle has been payed of over the term.

Is it not better to pay it out on a P & I and avoid paying all that interest?

 

[Sim]

Reply: 1
From: Sim' Hampel


Rolf and co. can probably answer this better than I, but I would believe that after your 10 year IO term, it would automatically revert to a P&I loan for 15 years or similar. Alternatively you could refinance to another IO loan or a P&I loan with a different term.

As for paying extra interest, you are indeed correct that you will pay a lot more interest on an IO loan than you would on a P&I loan.

The point is that by paying P&I, you must pay not only the interest, but the principal as well, which is generally a significant amount of money, and would make a fairly big dent in your cashflow.

The question is though, what could you do with the extra cashflow if you weren't paying off the principal ?

If you were just going to spend the extra cashflow you would have from an IO loan, or save it in a bank/term deposit/cash management account etc... then you would be way better off to have gone P&I.

However, if you were to go IO, and are able to invest that extra cashflow into additional growth assets which would make you money, the gains to be had could far outweigh the extra interest you will pay by going IO rather than P&I.

Of course, if you had personal debt, or non-investment debt (such as a PPOR), then going IO on your IP loan and using the extra cashflow to pay down some of your non-investment debt could also work well as it is more tax effective overall.

So it all comes down to what you will do with the money not being spent on principal repayments.