Motgage Types for Investment Properties?

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From: Ian Redman


Hi All,

Could somebody please try to explain to me how having an IO loan or P&I loan works for the length of the loan?.

Im sorry the question is very vague, so maybe i'll explain where im coming from and maybe that will help!!!

My fiance and I do not have our own home and we have purchased our first IP which we are due to settle on 22 Jan '02. We have gone with RAMS and have a revolving line of credit type loan. We were under the impression that this would give us equity faster to purchase another one.

After a very brief discussion on the chat room yesterday, it appears that this is not the best type of loan because we will be paying it off with the tenants rent and our own money!!!. In effect we are just saving for our retirement!!!.

The advise that came from the brief chat was to go for an IO loan from one of the major lenders and save our money to purchase the next property, maybe using an offset mortgage with a redraw facility.

As I explained earlier we are due to settle in Jan '02 and Im affraid that we are going down the wrong road.

Could somebody explain and try to point us in the right direction so we don't start off on the wrong foot.

Thanks in Advance

Ian Redman
 
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Reply: 1
From: Rolf Latham


Hi Ian

There is no right or wrong - the fact that you are moving forward is right, and that you are seeking more information is also right.

If you are on a revolving line of credit then there is no major problem, since by definition these are interest only with Principal reduction at your option.

The two major drawbacks with LOCs are:

1. Rate cost, commonly more expensive than more simple products in the same stable.

2. If you park your money in the LOC thereby reducing interest and then REDRAW that money for a private purpose, say a motor car, then the interest on the redrawn amount is no longer tax dedcutible, since it is for a private purpose.

The I/O vs P&I debate will go on forever and a day.

If you wish to build a portfolio more quickly then most of your loan should go onto I/O. This allows your loose cash to build and use for deposit for next IP, and so on.

Another but similar school says why pay for my property with current dollars rather than future (less valuable dollars). For eg if you had bought a 20 000 house in 1973 that houes is now worth 400 000. 20 000 was a lot of money in 1973, inflation has made 20 000 not a lot of money today. So the argument goes that you hold the property on interest only, and pay it out with deflated dollars (isnt that right DUNC :eek:)

Ta

ROlf

PS If youre on the product that I think youre on, you will find its a P&I all in one loan, which is fine for a home loan, and okish for an investment loan. There are better.


Rolf
 
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Reply: 1.1
From: Roderick Aguilar


Good points Rolf,

Ian, here's a few more stories to help elaborate on things:

I had to answer the same question when I was just starting out. And it’s a crucial one to understand in order to be successful in investing in property. Best way to explain the difference is to tell two stories and then you can decide which one is best for you. There is no right or wrong as it usually comes down to individual situations. Each to their own, so try and understand the different concepts then make up your own mind.

INTEREST ONLY
One of Peter Spann’s “rules” is “the biggest revenge I can give to the banks is to die owing them a lot of money!”. Once he dies, he can’t take the properties with him so it doesn’t matter what the banks does with it. All he wants is to live a life of financial independence off the assets, which the banks own by the way. He doesn’t ever want to own them, that is, he doesn’t ever want to pay off the loan. He’s happy for the banks to own them as all he needs to live comfortably is to have the title say that he “owns” the properties and live off the equity. There is the matter with passing on your debts to your kids but if have your Trust own all your assets and nothing in your name then you have effectively overcome this hurdle. So his thinking is that if the banks wish to throw millions of dollars at him then he’ll gladly take it as he knows he does not ever intend to pay them back. With this strategy, you have to be comfortable with a lot of debt. The banks won’t lend you the money unless they think you have the capacity to pay them back. But if for some reason, the bank offers you a multi-million dollar loan, then Peter says take it!

A lady bought a property in St Ives (an expensive area in Sydney) 30 years ago (1971) for $11,000 pounds. This was a lot of money in those days. Now if the banks had offered Interest only loans 30 years ago then that means that over thirty years she has only paid off the interest and NOT any of the principal. This means that after thirty years, by 2001 she still owes the bank $11,000 pounds. The house is now worth $768,000 dollars and she owes the bank $11,000 pounds which equates to about $33,000 dollars I think. In any case, 30 years on, she could easily pay out the debt. Because the one thing that Peter Spann rides on is that money “halves in value every ten years”. So money is worth much less in 30 years and hence he only goes for Interest Only loans.

With Interest only, it might cost you $50 a week to hold a $200,000 property. But with Principal + Interest it might cost you $180 a week. So Interest Only makes owning a house more affordable as well as enable you to own more than two houses.


PRINCIPAL+INTEREST
Many like owning their house outright. Many are uncomfortable with the banks owning their properties. The prices in Sydney are ridiculous at this point in time and the market is currently overheated. Many are predicting a correction in the property prices. Some are also predicting a major recession or even a depression in 2006 or 2008 whichever you wish to believe. In this case, in a depression, it would make sense to own the property and have no commitments to the banks. Most property investors rely on rental income to help pay off the banks. In a depression, if they have say 100 houses and 10 of them became vacant for a long period of time, servicing all 100 loans would become difficult to say the least.

Michael Pettett talks about having a “fundamental” group of properties that are fully paid off that are easily rented even in times of a depression. This way, no matter what the economy does, he can exit the market for two years by selling off his properties which the banks own and live off his fundamentals and re-enter the market when the time is right again. Owning properties outright gives you this flexibility.

The other thing with owning properties outright is the tax implications. Once you have fully paid off a house and are earning an income, the government wants a piece of that income too. Many first-time investors who have paid off their first investment are finding that they have to immediately buy a second property otherwise they would end up getting a large tax bill in that financial year. This keeps them forever in debt.

I hope this explains the differences between the two but the best thing is to talk to a clued up accountant to map out your strategy. Having done that you should then get a very good mortgage broker to shop around for the best loan for you. I have the names of a very good accountant and an excellent mortgage broker that has always managed to get me the best loans. But since you are running out of time then email me on rod.aguilar@aimnet.com.au and we should meet up for coffee for a chat.

Cheers,

Rod Aguilar
 
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Reply: 1.1.1
From: Ian Redman


Thank you both Rolf and Rod for your most valuable information.

Would I be right in saying that maybe we should go with an IO loan as we plan to marry in 18 months and the fiance's car will probably not last much longer?.

Thanks again in advance

Ian Redman
 
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Reply: 1.1.1.1
From: Ian Redman


Hi Guys,

Sorry to keep milking information from you. I know getting into the IP market is the right thing but being a novice so many questions keep coming up, and when you receive an answer more questions arise from that answer!!!.

I am now convinced that I/O is the way to go because of the Tax advantages and the fact that money depreciates with time, so my question is:-

Can anybody advise us where to put our savings money for the next IP?. We currently put our money in ING but with 4.5% interest, if capital growth falls here in Melbourne it will take us a while to purchase the next IP.

Thanks Once Again

Ian Redman
 
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Reply: 1.1.1.1.1
From: Roderick Aguilar


Hi Ian,

I am a bit concerned about how you plan to use your revolving line of credit. Peter Spann says that a revolving line of credit is not for everyone. It only works for those that are VERY disciplined otherwise their debt can get out of control. You should only use the line-of-credit (LOC) to purchase things that will produce an income. eg. a house or unit where you can get capital growth and rental income or in shares where you can get capital growth or dividends. In other words, don't spend it in things that depreciate. eg. Don't spend it on clothes, dinners, holidays, cars or weddings. Because a car depreciates in value as soon as it hits the tarmac and when you come back from your holiday you have nothing to show for what you've spent. You can get yourself into a lot of trouble if you do not follow this 'rule' about LOCs. My wife and I paid for our own wedding and it took us about 18 months to save up for it. We did not use the LOC.

I did not realise you were in Melbourne. I am in Sydney so it will be a bit difficult to have a meeting face to face. So this forum will have to do for the time being.

As for your question on where to park your money, I pour mine back into my main revolving line of credit. Because of our overall strategy I have the following in place:

1) A split loan with a bank.
(i) A principal and interest loan for $50,000. - This is where I park all our income into. Because it is principal and interest, the longer my wife's and my salary is in there the more it is paying off this portion of the loan. In other words, our money is working harder than it being in a savings account. In addition, we have a 55-day interest free credit card linked to this so that we use the bank's money for 54 days instead of using cash so that our salaries and other income stays in this account longer working away at this portion of the loan. This helps a lot as the banks calculate interest on a daily basis.

(ii) The rest of my loan is in an Interest-Only revolving line of credit. This I use for writing out cheques for the 20% deposit after I have purchased a house/unit.

2) A portfolio loan with another bank.
This loan is an Interest-Only revolving line of credit. I use this to pay for the other 80% when purchasing a house/unit. Although the properties are all in separate loan accounts, this bank allows me to pool all my properties together so that I may borrow the maximum amount possible for purchasing other IPs.

3) A Principal+Interest loan with another bank.
This is a pre-approved loan for my WRAP deal. I will soon begin to earn from a Wrap once the property settles. I had to take out a separate P+I loan as this is a requirement for making a WRAP deal work. Although I could have used my IO Portfolio loan above to purchase the wrap, to manage my risks, it is best that I had a P+I loan for the wrap.

You can also park your money in shares, which are not as good as cash but is also considered to be quite liquid. But that's another story.


Cheers,

Rod Aguilar
 
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Reply: 1.1.1.1.2
From: Rolf Latham


Hi Ian

If your using an offset account type product that works on an interest only loan, then simply park your money in that.

If you are using a redraw loan then park your money in that.

In either case you will be "earning" interest at whatever the rate of the loan is.

Ta
Rolf
 
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Reply: 1.1.1.1.3
From: Rolf Latham


Ian

PS to my previous post.

Why do you think this site exists ?

Tis for people to ask questions :eek:), so dont feel,silly, embarassed or guilty.

Everyone here was at some time where you are now, so they can relate really well.

Ta

Rolf
 
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Reply: 1.1.1.1.3.1
From: Ian Redman


Thanks once again guys for the info supplied, and I would also like to thank the people who make this forum possible. I have learnt so much in the few weeks that I have been visiting the forum, it is better than reading a book or attending any seminar

Cheers and have a great Xmas and New Year

Ian Redman
 
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