pros & cons: IO Redraw versus LOC

[bonanzawealth]

After unlocking some equity from PPOR, many elite brokers in this forum mentioned about using IO redraw and LOC. Could anyone please highlight the pros and cons between these two?

Extra question: is LVR 80% is the way to go for 1st IP when using the equity from PPOR? Somehow I read other thread that said 88% LVR is ideal if LMI is involved. I guess this depends in the risk tolerance, yes? Or is it better to stick at 80% so that it wouldn't cause so much issue for in acquiring 2nd IP?

Thanks again for the enlightenment

 

[Terry_w]

You just have to worry about mixing borrowed and non borrowed money together. The problem with some IO loans is that you cannot pay someone directly from the loan account. This means money has to be removed from the loan (i.e. borrowed) and put into a savings account and from there to be paid for the investment expense. This often means people mixing borrowed money with non borrowed money. This destroys the full deductibility of interest and it must therefore be apportioned.

some IO loans must be paid down at settlement into another account.

The benefit of a LOC is that you can use the money when you want, pay money directly from the LOC account. Maybe even get a cheque book. Some LOCs even allow capitalising of interest (get advice).

The disadvantage of a LOC is that they are often at call - not a 30 year term like a 'normal' loan. Rate is often 0.15% higher. Broker commission is less - 70% of 80% of the commission of a term loan.

If you can manage a IO loan with redraw this may be ok, but a LOC can be easier to use. An LOC can also be changed to an IO loan once the money has been used.

The lender has a lot to do with it. For lenders such as ANZ I prefer a LOC, but Macquarie an IO loan would be ok. Suncorp would be a LOC.

You should never use a LOC for the main loan on a property, but only for acccessing equity. NEVER use a LOC for an investment loan and put wages in and out - this would be a disaster.

 

[Terry_w]

2nd question.

Whether you go 80% or over will depend on how much equity you have and how far you want to go and how quick you want to get there.

Small amount of equity may mean you want to put in lower deposits to stretch things further.

 

[bonanzawealth]

Thanks Terry, your insight is always top notch!

is it normal to use LOC to pay for deposit and cost for purchasing IP?

 

[Terry_w]

Thanks Terry, your insight is always top notch!

is it normal to use LOC to pay for deposit and cost for purchasing IP?

Normal - not sure. It is my preferred method but probably the most common way people do it is the mistaken way of paying cash and/or cross collateralising securities.

 

[Peter_Tersteeg]

After unlocking some equity from PPOR, many elite brokers in this forum mentioned about using IO redraw and LOC. Could anyone please highlight the pros and cons between these two?

Some lenders I/O products can be used in the same manner as a LOC. In these cases there's probably no significant advantage to a LOC product. Quite a few lenders allow their variable loans to include facilities such as direct payments and BPay.

A LOC is generally an 'evergreen' product which stays interest only for the life of the loan. A regular loan will usually default to 5 years interest only, but there are lenders that will go as far as 15 years without too much hassle. Eventually though a regular loan is going to need reworking to keep it I/O forever.

A big problem with a LOC is many people have a perception that it's an unsecured loan. They often won't disclose a LOC when asked about the loans against a property and some clients have been adamant that their LOC is not secured by their (only) property. A LOC credit is another loan, just like your variable or fixed loan. It's got a different name and a few different features. It's still a mortgage.

Extra question: is LVR 80% is the way to go for 1st IP when using the equity from PPOR? Somehow I read other thread that said 88% LVR is ideal if LMI is involved. I guess this depends in the risk tolerance, yes? Or is it better to stick at 80% so that it wouldn't cause so much issue for in acquiring 2nd IP?

[/QUOTE]

Most lenders will charge higher interest rates and have more difficult assessment criteria once loans go over 90% LVR. Assessment criteria usually isn't a problem, but the cost difference of rates can be significant. The figure of 88% is often used for a few reasons.

Only a few lenders will allow you to capitalise the LMI onto the loan over 90% and not charge more. As a result many people look to 88% + LMI to a total of 90% LVR. In reality it's actually closer to 88.5% + LMI. Another good reason is there's a significant price point for many LMI policies between 88% and 89% LVR. By borrowing below 89% you can sometimes save a reasonable amount.