Newbie: Principal and Interest loans??

[aliasforsydney]

Hi, I was interested in buying my first IP. I'm on a low income though, and I'm afraid that I will only be able to afford an interest only loan... It may seem kinda funny, but I'm a bit scared of how this would work as shouldn't I be paying off the loan as well as the interest and how would I pay off the loan later??

 

[Simon]

Pay it off later when inflation has eroded the net worth of the loan, your income is higher, and you have other income generating assets.

See it as a part of an overall strategy.

I'm back now everyone!

Ciao,

 

[twobobsworth]

Maybe pick up Michael Yardley's book to start with.

 

[steveadl]

Good to have you back Simon!

Alias, there will be a fair few threads on the IO subject if you do a search. There is no wrong answer, it's up to the individual, but basically it makes your servicability better so you can afford multiple properties sooner.

In the big scheme of things, it doesn't make a huge amount of difference whether you pay the loan principal down or not. If you buy a house next year for $400k, and in 20yrs it's worth $1.5m - you will have $1.1m worth of equity in it. Does it really matter that you didn't pay down the initial debt? Yes you'd have $0 debt if you did, but then you may not have gotten that second IP in year 4 etc....

 

[BayView]

Pay it off later when inflation has eroded the net worth of the loan, your income is higher, and you have other income generating assets.

See it as a part of an overall strategy.

I'm back now everyone!

Ciao,

Good to see, Simon!

On the P&I v IO scenario;

I remember first hearing about this several years ago and was amazed that a Bank would even let you do it.

Of course; as your knowledge increases a lot of the stuff you hear here will become mundane.

IO allows you to maximise your cashflow. The interest is tax deductible and you can still pay off principle whenever you want.

A good thing to do is always pay your tax return into the loan as a principle payment.

 

[skater]

I am supposing this property is to be an investment & not your ultimate home. If this is the case, what I would do is as follows.

Get a loan for the max you can afford. Go interest only. Have an offset account setup alongside the loan. Put all your spare money into the offset account. This will have the effect of paying P & I, while keeping the original amount of the loan.

So, keeping to round figures, say you have a loan of 100k & you deposit $10k into your offset account. You will only have to pay interest on $90k. So at a later date, you can use the funds accumulated in the offset account to fund your next deposit (PPOR perhaps).

 

[alexlee]

Hi, I was interested in buying my first IP. I'm on a low income though, and I'm afraid that I will only be able to afford an interest only loan... It may seem kinda funny, but I'm a bit scared of how this would work as shouldn't I be paying off the loan as well as the interest and how would I pay off the loan later??

With a bit of time, quite simply, your original loan would mean nothing.

Say you start with a $200k property, borrowing $200k. In 20 years, the property goes to $800k. You've never paid a cent off the mortgage, but you have $600k in equity. How do you pay it off? You don't have to: 25% LVR would be very conservative. At that point, your rent would be way more than your interest anyway.

Also, your income will increase.
Alex

 

[Simon]

I am supposing this property is to be an investment & not your ultimate home. If this is the case, what I would do is as follows.

Get a loan for the max you can afford. Go interest only. Have an offset account setup alongside the loan. Put all your spare money into the offset account. This will have the effect of paying P & I, while keeping the original amount of the loan.

So, keeping to round figures, say you have a loan of 100k & you deposit $10k into your offset account. You will only have to pay interest on $90k. So at a later date, you can use the funds accumulated in the offset account to fund your next deposit (PPOR perhaps).

This is what I like to discuss with people who are buying a first home. Gives you choices later and the best of both worlds.

 

[casper007]

I am supposing this property is to be an investment & not your ultimate home. If this is the case, what I would do is as follows.

Get a loan for the max you can afford. Go interest only. Have an offset account setup alongside the loan. Put all your spare money into the offset account. This will have the effect of paying P & I, while keeping the original amount of the loan.

So, keeping to round figures, say you have a loan of 100k & you deposit $10k into your offset account. You will only have to pay interest on $90k. So at a later date, you can use the funds accumulated in the offset account to fund your next deposit (PPOR perhaps).

Assuming you also have a loan on a PPOR then I would follow Skaters advice with a small twist ... align the offset account with your PPOR ... if you can affort extra in repayments, then reduce your non income producing (tax benefitial) debt first.

casper

 

[eng]

I need some help with my offset account for my PPOR. Basically, in my case with Westpac, I have 129.6k loan for my land and around 20k sitting in my offset account. I'm suppose to be on interest only repayments until the house finishes building but....

- after 2 fornightly repayments
-----> offset account got about $860 deducted and
-----> loan account had $200 taken off the principle.

my online statement says 2 X $413 deductions for mortgage and total interest $613.

is this correct?

So at a later date, you can use the funds accumulated in the offset account to fund your next deposit (PPOR perhaps).

How could I build up the amount in the offset account if repayments are deducted from it?

 

[alexlee]

How could I build up the amount in the offset account if repayments are deducted from it?

Put in more money than your payments. How else do you save?

 

[skater]

How could I build up the amount in the offset account if repayments are deducted from it?

Use it as a savings account.

 

[eng]

I see. I thought they bank should credit back the interest that I saved back into the offset account instead of deducting it off the principle. Thanks. I'm a noob to all this as someone said the loan amount will always be the same.

 

[alexlee]

I see. I thought they bank should credit back the interest that I saved back into the offset account instead of deducting it off the principle. Thanks. I'm a noob to all this as someone said the loan amount will always be the same.

I don't think you're paying interest only on your loan, eng.

 

[Ebbie]

Slightly off the topic, but if you make monthly principal and interest repayments do you have to work out the interest portion for yourself (for tax purposes)?

I've only ever had interest only loans before and one of my loans has just reverted to monthly principal & interest repayments. The bank statement shows the total repayment and doesn't break it down for me, making it difficult to enter the interest portion into my MYOB records.

Do financial institutions usually provide an end of financial year statement showing the total interest paid or do you have to work this out yourself?

 

[Jamie M]

Your statement should show the breakdown.

 

[Jamie M]

Go interest only. Have an offset account setup alongside the loan. Put all your spare money into the offset account. This will have the effect of paying P & I, while keeping the original amount of the loan.

Agree 100% - good advice.

However, normally I would recommend that if you lack the discipline required to make regular repayments into your offset account then P&I might be best.

If you think you can only service an IO loan now as opposed to a P&I loan then perhaps it's not the right time to be purchasing. You may want to wait until your income is a little higher and the loan won't be as much of burden on your financial situation.

 

[Tillie]

I already posted this one to the other thread, but the question might be better suited under this topic.

As a newbie in the property investment field I would like to know, how you are planning to pay the loan off eventually if you pay only interest not principle at all. Or is the plan to buy now IP and sell few years later, hope some capital growth and use the profit to pay off the original loan and reduce the loan in other IPs?

 

[artlez]

I already posted this one to the other thread, but the question might be better suited under this topic.

As a newbie in the property investment field I would like to know, how you are planning to pay the loan off eventually if you pay only interest not principle at all. Or is the plan to buy now IP and sell few years later, hope some capital growth and use the profit to pay off the original loan and reduce the loan in other IPs?

It was pretty well answered earlier in this thread but you can just not sell and just service the mortgage easily off the rent coming from it. The rent will increase over time so it will become cashflow positive, and over time the loan gets whittled away by inflation. Most people just refinance to get another IO loan once their original IO loan expires.

 

[mary&mat]

I already posted this one to the other thread, but the question might be better suited under this topic.

As a newbie in the property investment field I would like to know, how you are planning to pay the loan off eventually if you pay only interest not principle at all. Or is the plan to buy now IP and sell few years later, hope some capital growth and use the profit to pay off the original loan and reduce the loan in other IPs?

Hi Tillie,

Some strategies (like mine) are to never pay the loan off. That way you're using other people's money (OPM) to make your money. By OPM I mean, the person paying the rent or the bank's LOC (line of credit) to pay the loan (debt recycling).