New loan charging less interest upfront

[joy]

Hi all,

What do you think of this new loan?

Investors Direct has a new loan that you pay almost half the interest now and the rest is capitalised. It means that if I swap my house over to it, instead of being $8000 negative, I end up with around $3000 in my pocket for the year. It's an 80% LVR. The capital growth should overtake the interest being capitalised so that I can refinance down in 5 years and have a positive outcome. What do you think?

Thanks

Joy

 

[Mary]

... The capital growth should overtake the interest being capitalised so that I can refinance down in 5 years and have a positive outcome. What do you think?Joy

Sounds like a good product for those with debt servicing problems but:

- if you refinance 5 yrs later you then have a higher debt which you also need to service. But i guess the rent has also increased to help this as well though?

- if the interest is capitalised, your debt is higher down the track thus requiring higher repayments?

 

[geoffw]

I believe that it's structured something like 2.6% in the first year, with the balance capitalised, higher in the next year, almost full rate in the third year.

It was mentioned in this thread; it will be discussed at seminars later this month.

Yes, your total debt does become higher.

 

[rambada]

I have had some information on this and have a consultation next week. At this stage I am cautiously optimistic.
Doing the figures on API, the IRR is slightly better in the short term and in the long term very slightly worse - insignificant really.
I believe the key is what you do with the increased cash flow, as the part you are not paying is capitalising. I think if the excess money is reinvested then it is a winner, if you blow it then it is probably still ok but not for those that are conservative.
Please excuse me not posting details as I am unsure of confidentiality from Investors Direct. Once I've clarified this and if appropriate I will up date.
Certainly a product worth exploring.

 

[tubs]

I've heard about it too, and I'm eagerly looking forward to more information. What it'll mean for us is that we can invest in the very high growth, but very negatively geared areas which we can't get into because of being unable to service the loans. This means the rich, inner suburbs which are growing at (according to Residex) 16%+ pa are on the radar, which means we'll accumulate wealth much faster than the 8% growth properties we're limited to.

Of course, it all depends on the fine print but if it means we can get into really high growth areas fast, its got to be a winner.

 

[willy1111]

I can't really see how the loan is any different to Bill's usual theory of using debt to service debt - except the interest rate being about 1% higher than a pro pack interest rate in the first few years.

The interest rate is 7.95% for the first 4 or 5 years and then drops to 7.45%. However in the first few years, the interest is broken up - so that in Year 1 you only have to phisically pay about 3.4% out of your own resources and let the balance accrue on to the loan. So if you bought a poperty for $300,000 - borrow $240,000 (80%) - the interest bill is $19,080, you pay 8,160, and let the $10,920 be added to your original loan so at the end of the year the loan amount is $250,920.

In the second year, I think it is about 4 something % that you pay out of your resources and so on.

The loan starts at 80% and you can capitilise the interest upto about 90% - no LMI.

I guess it is just another tool to have in the tool kit.

 

[mja]

Hi all,

What do you think of this new loan?

Investors Direct has a new loan that you pay almost half the interest now and the rest is capitalised. It means that if I swap my house over to it, instead of being $8000 negative, I end up with around $3000 in my pocket for the year. It's an 80% LVR. The capital growth should overtake the interest being capitalised so that I can refinance down in 5 years and have a positive outcome. What do you think?

Thanks

Joy

Hi,

Just so you know, you can't use this product on your PPOR.

-- MJ.

 

[D.T.]

MJA, I think Joy was alluding to it not being her ppor with the "instead of it being $8000 negative" part.

 

[Barracuda]

Careful

Hi all,

What do you think of this new loan?

Investors Direct has a new loan that you pay almost half the interest now and the rest is capitalised. It means that if I swap my house over to it, instead of being $8000 negative, I end up with around $3000 in my pocket for the year. It's an 80% LVR. The capital growth should overtake the interest being capitalised so that I can refinance down in 5 years and have a positive outcome. What do you think?

Thanks

Joy

Joy,

What your discussing is a Graduated Payment Mortgage (GPM). Have a look at the attached image and you can see that the amount owing will increase over the initial period, meaning that your repayments over the pay-down period later in the loan are much higher (you now have more to pay off in less time). I would expect bigger break fees, etc that would limit your ability to refinance during the early years of the loan.

Another point to note, because your principle is growing due to capitalising interest (and if your lucky so is the property), the amount of equity available is less than that available if it was a IO loan.

I'd personally be very wary of this product - you'll pay much more over the life of the loan (the area under the graph) as compared to a P&I loan (CPM in the graph - constant payment mortgage), and will need to find even more money for repayments after the honeymoon is over - regardless of whether your property has gone up in value or not.

I see it as a predatory product looking for a victim.

Hope that helps you visualise the nature of the loan.

Cheers,

 

[willy1111]

After 2 years I believe it is free of penalty.

You may be able to refinance it again after 2-3 years, and have it positive cashflow again.

As I see it, this type of loan is for people who use debt to pay debt.

If you don't use debt to pay debt - or don't want to use debt to pay debt - then I would suggest the loan is not for you.

 

[twodogs]

After 2 years I believe it is free of penalty.

You may be able to refinance it again after 2-3 years, and have it positive cashflow again.

As I see it, this type of loan is for people who use debt to pay debt.

If you don't use debt to pay debt - or don't want to use debt to pay debt - then I would suggest the loan is not for you.

I suppose it's good to have such a product available, but there are other ways to fund debt with debt. With better rates and more flexibility. Not sure of tax deductibility with this way either, whereas borrowing for interest payments can be a deductable debt.

 

[emu]

I suppose it's good to have such a product available, but there are other ways to fund debt with debt. With better rates and more flexibility. Not sure of tax deductibility with this way either, whereas borrowing for interest payments can be a deductable debt.

I attended the seminar in melb last sunday and after bill zheng had explained the concept my thoughts were similar as maniyaks.

It's the same principal as capitalising interest, see below thread, but you pay a premium for having it structured into a loan.http://www.somersoft.com/forums/showthread.php?t=26532

The capitalising is not flexable, but corsa's model above is.

This will be a great product for investors who for some reason or another, don't have the time or interest in setting up their own structure to make this possible..............and i think corsa's structure offers one of the best safety nets available.

 

[mja]

MJA, I think Joy was alluding to it not being her ppor with the "instead of it being $8000 negative" part.

Hi Dave,

Yeah I was thinking PPOR when I saw this phrase by Joy:

"It means that if I swap my house over to it"



-- MJ.

 

[DavidMc]

I'd personally be very wary of this product - you'll pay much more over the life of the loan (the area under the graph) as compared to a P&I loan (CPM in the graph - constant payment mortgage), and will need to find even more money for repayments after the honeymoon is over - regardless of whether your property has gone up in value or not.

I see it as a predatory product looking for a victim.

Hope that helps you visualise the nature of the loan.

Kudos to you for a great post. The graph clearly shows how this product works.

However, in my opinion I think your comments are a little too harsh. I think this product would be a good way for a first time property investor with little savings or equity to secure a high growth/low yield asset. It might also give investors more comfort as this cashflow is more guaranteed than future capital growth. Like anything, you do pay a premium for it.

If I were Bill I would have made the break fees much higher or last for the life of the loan, as I can't imagine why anyone would stay with this product after year 4 or whenever the interest stops being fully capitalised.

 

[grossreal]

Hi all
Capitalised interest is very good if you have a very good exit stratigy but if you are looking at capitalising simply to reduce the out goings at the start and hoping for growth in the property to cover the increase in loan.
This is a very risky road to run as you have to be sure that the tennant is going to be with you for the whole race.
If this product was aimed at comm properties I would feel a bit more at ease but for resi to compound interest and pay latter.
It would be get out the big piece of paper and a new pencil and do alot of working out.
and DavidMc if this is aimed at the first time property investor then even more the reason not to get involved as I am not sure they would have the knowledge or the understanding of how they are going to refinance a property.
That in essence will be oweing more then they paid for it as it will have the principle and the capitalised interest that is yet to be charged.
The only market that I would feel safe with this product would be the comm market with a 5 x 5 lease in place and you used the lower interest rate to cover the loan and you held the difference in funds (the money you would have paid out in a normal loan) in an offset account and held it there to use for later investments.
or if enough, term deposited it and equity lend against the term deposit.(not a first time invested thing to do).
I am yet to get the full run down on this product but anything that is capitalised at the end of the capitalise term.
You must pay off that capitalist interest part ( developers will understand as you move it default interest with lenders and this is the deathnell time for developments if you don't cover this interest).
2 and 3% interest looks good but default interest is very expensive(suncorp is 14.5% on the whole amount, anz is 15.9% again on the whole amount).
my advice is tread very carefully and check all the defaults before going into these types of lends.
and if private lending.
The requirement for return is around 11% per annum so if you have paid 3% for 4 years then the default is 32% to break even.the cost of the money is 24% over the 4 years roughly so min would be 12% max 32%.
example
have a look at the harvey norman ge interest free 24 month deal min 500.00 purchase
yes it is interest free but the cost of the use of the card is $20 per month per transaction the interest is 0 but the account keeping fees over the 24 months is 480.00 and the items not payed off yet. hence I don't have a ge card
nothing wrong with ge its how to do business and for them a very good way.
look at all costs and exits charges.
and (DavidMc)
"If I were Bill I would have made the break fees much higher or last for the life of the loan, as I can't imagine why anyone would stay with this product after year 4 or whenever the interest stops being fully capitalised"
is relatively simple you would need to renegotiate with this lender as you would have no other lender that would be able to cover the loan at there lvr ratio's.
as the loan would be 100 and something of the value.
and god forbid you bought in an area that corrected and the value went down in the term of the loan.
my .002

 

[rambada]

I think it would depend on what you did with the 'extra cashflow'. If you reinvested this into a fund or CPT, then I could see the product working well. I have an appointment tommorow with Investors Direct and am looking forward to playing with their spreadsheet. Have tried to put it into PIA but can't get it to gel. Will take their data and assess it based on reinvestment.
My other thought is that I use a similar system to Corsa's model and have been for some time. By utilising the 'Cash Flow Loan', reinvesting the returns within my cashflow system, then it is good value.
Early days fof assessment but cautiously optimistic.

 

[DavidMc]

Hi all,

I put a few numbers through Excel just to see some figures on how this style of loan compares with a regular interest only loan on a $350,000 property at an 80% lend. All other variables are in the spreadsheet and you can change them.

In summary, after five years:
The GPM (cashflow) loan you are over $25k better off in terms of cashflow.
The CPM (regular IO) loan you are $19k better off net.

Observations - as expected this product delivers better cashflow during the inital few years of the loan. The overall net position though is worse than a regular loan and will continue to worsen over the life of the loan.

I still think it can be a good product for some. For example:
Those who aren't comfortable with using debt to service debt manually and would like this built into their loan.
Those who have limited cashflow but plenty of equity.
Those who understand the risk of such a product (capital growth may not occur).
Those who believe that the potential growth will be as per the long term averages.
Those who understand how to re-finance (or have a good broker) to move to a better deal after the interest capitalisation period is finished.

It's not for me, as I do the same thing outside of this loan and therefore pay a reduced interest rate (i.e. revaluing and refinancing yearly, drawing up, etc).

- At 3% growth pa over 5 years the gain on a $350k property would be $55,745.
- At 5% growth pa over 5 years the gain on a $350k property would be $96,698.
- At 7% growth pa over 5 years the gain on a $350k property would be $140,893.

In this above example, you would want an average of just over 4% CG pa using a GPM product just to break even.

(Please let me know of any errors!).


Cheers,

David.

 

[mja]

Hi David,

I spoke with someone from Investor's Direct today.

It's a 5 year fixed loan at 7.95%.

First year: 3.7% interest, 4.25% capitalised.
Second year: 4.95%, 3% capitalised.
etc.

So after 2 years, you can just get the whole thing refinanced and start again. I'm sure there would be some break cost, considering it's a fixed loan though...

I'll find more pertinent details this weekend.

-- MJ.

 

[emu]

Hi David,

So after 2 years, you can just get the whole thing refinanced and start again. I'm sure there would be some break cost, considering it's a fixed loan though...


-- MJ.

My understanding is that there are no break cost fee's if you refinance within two years

 

[DavidMc]

My understanding is that there are no break cost fee's if you refinance within two years

I'm assuming you mean after two years.

It seems strange. I've never heard of a 5 year fixed loan that you can get out of after two years without penalty. What happens if people sign up at 7.95% fixed for 5 years, then interest rates drop to say 5% (silly example, but not impossible), everyone would just leave? The lender isn't covering their downside.