Simulation Software or spreadsheet?



From: Dr IT

Hi! Hi!

I want to perform some simulation for the following purposes:-

1) if I pay P&I on an IP or if I pay IO only, which one will I be better off; bearing in mind of the +ve cash flow from the P&I.

I have seen so many suggesting towards IO only for an IP but I really need the real figures to justify that. My initial thought would be to paid P&I first so that the property can be +ve cash flow quickly and revert to IO so that I can concentrate on another IP. Any expert pointer for the wannabe :)-)).

Many thanks in advance.

Dr I. T.

<TD BGCOLOR=green>
Fortune knocks but once, but misfortune has much more patience. - Dr. Laurence J. Peter

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Reply: 1
From: Ms Flip

From what you are saying is that you want to pay P&I to start with because the property is Neg geared??

I am paying P&I on a few properties and they are still Pos geared.

It all becomes a matter of cashflow. IO will provide you with a larger cashflow then a P&I loan. It really comes down to your own circumstances and situations with the individual property.

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Reply: 2
From: Rasputin .

Dont you mean +ve cashflow from the IO . If you are paying P&I then your cashflow will be less as your outgoings have increased.
From what I read most think that you should use the +ve cash flow by paying IO and get another property. This would all depend on how much equity you create in IP from Capital Growth of property.

Just my .02c worth
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Reply: 2.1
From: Dr IT

Many thanks to the suggestions.

Ms Flip is correct. The IP I am currently looking at is -ve geared at this point. That is why I am thinking (aloud) to use P&I initially. Secondly, I do not really want more property (just enough property that I can really control).

Lastly, Rasputin - Ma Baker (correct spelling?) is giving you a promotion. A 2 cents coin is not legal tender any more so now your opinion is worth 5 cents. How about that :)

Dr I.T.
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Reply: 1.1
From: Dr IT

Just a feedback to your signature.

You cannot use "D:\My Documents\GIFs\Ms Flip - reversed.gif" because that is your local drive. You must put your GIF file somewhere on the internet (preferably on your home page).


Dr I.T.
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Reply: 2.1.1
From: Paul Zagoridis

Actually $0.02 is legal tender. You can EFT-POS, BPay, cheque or Funds Transfer as little as $0.01.

As for IO over P&I...

Principal repayments are not normally tax deductable. Therefore from a cashflow perspective IO is the way to go -- let inflation reduce the principal value for you.

Yes, if you pay the principal down, your interest payments reduce. In which case take an IO loan and deposit extra principal reductions as lump sums. A P&I loan amortises so slowly it is almost an IO for the first 2-3 years.


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Reply: 3
From: Terry Avery

Look at it this way. The more of your own dollars that you contribute to the
IP the lower your return. For example buy a property for $200,000 with no
deposit (using equity in own home?) and has a cap gain of $50,000

P&I payments of $10,000 over say five years
Return is 50,000/10,000 x 100 = 500% over the five years or 37.97% p.a.
compounding interest. Yippee, what a return on my money. Had the principal
repayments been higher, say $15,000 then the return would be
50,000/15,000 x 100 = 333% , or 27.23% p.a. compounding, so you can see the
more principal you put in the
lower the return on your money.

IO payments of principal is nil, OK calculator can't work it out with zero
so let's say we use a dollar as a deposit
Return is 50,000/1 x 100 = 5,000,000% (actually if you put nothing in then
the return is an infinite %) or 770.55% p.a. compounding

Now which return on your money would you rather have, gee tough one there!

Going IO you can use the principal payments to buy another IP so the way I
see it is you have to look at the return on the money you are putting into
the deal. Every principal payment has to be looked at in terms of what
return will the money give me. The more I put in the less leverage I have
and the lower the return.

Of course some people's sleep factor is affected if they don't pay down the
principal but if you look at it another way, when you buy a property you are
buying an option to sell the property at a higher price at some point in the
future. It is not necessary for you to own the property outright in order to
exercise the option to sell but when you sell then the profit you received
gives a higher return the less of your own money you put in. It has taken
ten years for my wife to grasp this but now that the penny has dropped she
is able to explain it better than I can.
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From: Paul Zagoridis

Here's a spreadsheet to show the difference between borrowing P&I and IO. It compares an amortization schedule with an IO loan over the same term.

It makes no affordability assumptions nor allows for acquiring extra property.
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Reply: 1.1.1
From: Ms Flip

Ohhh, are you telling me I you can't read my groovy signature??


I can read it.

Now I'm gonna have to find somewhere on the web to store it.

Ms Flip

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Reply: 3.1
From: Rasputin .

All depends on your invesment strategy you use. Paying off some Principal can increase your equity thereby allowing more IPs to be bought, of course the same money you use to pay Principal could be the cash dpeosit for next IP.. So many things to think of , so many ways of getting it done.. Not everyone is happy with so much debt, so those people will pay it off , (I tend to be one of those people) others love the GOOD debt of IPs and cant wait to be $1000000 in debt but with $2000000 of Assets...

As for upgrading my input to .05c I am not that worthy. I feel that I am more like the .01c input to be payed via EFTPOS ...
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Reply: 3.2
From: Dr IT


Thank you for your input. While it seemed to be very attractive, your calculation seemed to be missing another factor - the interest that you are paying.

This is what I think the calculation formulas should be. Let me know if I am flawed... :-(

Capital Gain= A (say $50,000)
Option1: For $10,000pa, interest paid=x
Option2: For $15,000pa, interest paid=y (x > y)
Option3: For IO only, interest paid=z (z > x > y)

Return for (Option1): (A - ($10,000*5+x))/($10,000*5+x)
Return for (Option2): (A - ($15,000*5+y))/($15,000*5+y)
Return for (Option3): (A - (z))/z)

Hence the real formula seemed to be:-
(A - out)/out = A/out - out/out = A/out - 1.

You are spot on in predicting that the return is depending on "out". The smallest the better. However, the million dollar question is which "out" is the smallest.

Dr I.T.
P/S I am no accountant so please correct me wherever possible.
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From: Dr IT


Thanks. I will look at during the week-end.

Dr I.T.

Tell me, and I forget. Show me, and I remember. But let me do, and I understand.
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Reply: 3.2.1
From: Rasputin .

I got lost with his formulaes too.. Percentage return surely must be over all money outgoings not just principal payments...
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From: The Wife

all that brain all really means nothing if you dont actually buy something.
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From: Dr IT

How true a statement! It is not that I am not trying just that so far I have been outbidded in not once but twice :-(.

In any case, having all this brain power means that at the very least, you and I could make an empowered decision.

Dr I.T.
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Reply: 3.2.2
From: Terry Avery

Dr IT,

No your thinking is not flawed, one of course must take into account the
interest paid when calculating the return on investment. One should also
subtract the costs of buying, selling and holding but as they are constants
whether you use a P&I loan or an IO loan one can just look at the capital
gain made. That leaves the interest as a variable as it decreases as the
principal is paid down.

My example was trying to keep things simple and demonstrate that every
dollar you put into a property must have a return otherwise you may just as
well stick the money in the bank. I was trying to illustrate that paying
down the principal will give you a lower return on your money and that the
money used to the pay the principal down may be employed more effectively by
investing in more property.

Following this logic I have focussed on all my expenses and where possible
try to minimise them, for example adequate insurance cover at the lowest
cost, no bank fees and so on. For every dollar that is input into the
property then my return is lowered.

I came to this conclusion using my own spreadsheet model which covers my
financial situation, including tax and other investments so the outcome may
be different for others and they should ponder their unique set of financial
circumstances. Which 'out' is smallest may be different for each investor
but I believe that paying down the principal gives peace of mind which is
traded off for a lower return.

I used the formula for compounding interest S=P*(1+i)^n transposed to find
the rate of return over a given period and so did not take into account the
different amounts of interest that would be paid with P&I or IO (given that
75% of interest is paid in the first 25% of the length of the loan there is
not a great difference). For simplicity I took the capital gain (sale
price - buy price) and took away any principal paid. If you were to factor
in the amount of extra interest according to your formulae I think you will
find the amount of extra interest paid is small and doesn't lower the
difference between the return from P&I and IO although the overall returns
will be lower for both. Perhaps you could put some figures into your
formulae and see if I am right?

Have I clarified my thinking or just confused everyone more.

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