Why would you choose P&I loan over IO?

Hi
Not sure if i understand all of this correctly, but i'll set up an example for ease of explanation.

get a loan requiring $1500/month interest, and if you were to get a P&I loan, you'd be paying an extra $700/month on top of that for a typical 30yr loan. if you were disciplined enough with your cash, so that you put in a "voluntary" $700 extra (on top of your IO repayment of $1500/month), you'd be paying your loan off at exactly the same rate as a P&I. I can't see any disadvantages of this technique, assuming you have the monetary discipline

Advantages however I see as below:
1) Access to a much higher amount of excess/offset cash, available to use on holidays, emergencies, or other small-to-medium cost items
2) If you want to buy a second place, you can use this excess/offset fund for a deposit. This amount will be much higher if you've got a IO loan. (i think) this is especially advantageous if looking to have the 2nd house under a loan with a different banking institution (?)

can someone add to the + and/or - items listed above. I consider myself as very disciplined with cashflow but am wondering why some MB's I've talked to say P&I is the way?!
cheers
 
I consider myself as very disciplined with cashflow but am wondering why some MB's I've talked to say P&I is the way?!

Barry, 2 things:
FOR 1. Find a property savvy MB to talk to. :p In most cases IO is better for property investors
AGAINST 1. Most human beings (unlike your disciplined good self) will spend any and all excess money they have access to ...and then some.

So IO does not suit those trying to pay off a PPOR for example.
 
My understanding is that the bank doesn't see putting money into an offset acct the same as paying the loan off, so after 5/10 years you'd either need to refinance or start paying principal.
 
I think this is an issue where often you will need to separate the psychological aspects from the logical economic aspects.

Yes if you're disciplined to save pay IO. You might then be even better off if you invested your savings in a tax advantaged regime such as superannuation. eg $8400 p.a after tax is $12,000 per year before tax at 30c/$, so if you salary sacrificed $12K into super you would after contributions tax of 15% have an annual investment of $10200 to earn on.

However, the $700 per month is probably your average principal reduction over 30 years so the difference between P & I and IO on $300K is only about $350 p.m.

Personally I am happy to pay P & I as part of my risk management strategy, also I think superannuation legislative change is high risk.
 
My understanding is that the bank doesn't see putting money into an offset acct the same as paying the loan off, so after 5/10 years you'd either need to refinance or start paying principal.

i don't care what the banks think, i only care that their calculators are taking my extra payments into consideration when they calculate my next month's (reduced) interest bill!
 
You average mum and dad mortgage broker would suggest a P & I loan every time as they dont now or understand the alternatives and certainly have probably hardly ever dealt with investors and their required structures.

The interest calculation is the same and as long as you are fairly disciplined and dont go and blow the entire offset account at the casino you will fair better in the long run when if comes to choice and flexibility.
 
reasons to pay PI instead of IO

a) pay down CF+ property debt - make it MORE CF+ as time goes by to make up for the common lack of CG.

b) you have a conservative investment strategy that is more about attaining/maintaining low LVRs

c) you might actually want to own the property outright, god forbid.

reasons to pay IO instead of PI

1) increase available cashflow to you by paying the absolute minimum possible to hold a property

2) it's a low yielding property therefore you want to minimise out of pocket expenses.

3) you can't afford anything else.

4) you're goign to put the difference between PI & IO repayments into an offset account so you have "cash at the ready" for the accumulation phase, not growth phase, of your investment portfolio.

5) your portfolio is speculative or highly geared (high LVR) therefore paying IO minimises risk exposure.
 
None for PI unless as you say you cant hold onto the P part of the payment and spend it.

In some scenarios, some lenders will lend more on a PI loan than an IO loan at the margins

Thats about it I reckon.

ta
rolf
 
reasons to pay PI instead of IO

c) you might actually want to own the property outright, god forbid.

Bluecard: regarding this point ^, if you were paying IO (which in most cases one won't be able to obtain for longer than 10yrs), say you had enough cash saved up in the offset account BEFORE the IO period expired. Once your offset amount is equal to the original loan amount, you officially then have the funds to pay for the property outright. How does this normally get done? do you get charged a fee (if so, is it a big one) for effectively moving the money from the offset/redraw account over to kill the loan & own outright?
 
NO fee for moving the money over, but usually a fee to get your title back.

Another advantage of IO with offset is if the purpose of the property changes. If you had paid off some principal, and then wanted to upgrade and keep the old as a rental, IO with offset will have greater tax advantages than P&I.

Its horses for courses though, depends on your risk profile etc.
 
barry2104 said:
in most cases one won't be able to obtain [I/O] for longer than 10yrs
Surely you can just "roll over" to a new I/O period?
barry2104 said:
Once your offset amount is equal to the original loan amount, you officially then have the funds to pay for the property outright. How does this normally get done? do you get charged a fee (if so, is it a big one) for effectively moving the money from the offset/redraw account over to kill the loan & own outright?
I guess if the loan was for a PPOR (ie non-deductible), and you wanted to borrow for an investment, then retiring the existing debt would make sense. But if you're planning on borrowing again, any other combination (ie both deductible, both non-deductible, or existing loan deductible and new loan non-deductible) would mean that there's no advantage paying off the property, rather than leaving the funds in the offset.
 
Surely you can just "roll over" to a new I/O period?

As happened to me recently, the bank actually wrote to me saying that they will roll over the interest only payment loan which was coming up to the 5 years expiry. They extended the interest only loan for another 5 years. I didn't have to do anything.
 
You average mum and dad mortgage broker would suggest a P & I loan every time as they dont now or understand the alternatives and certainly have probably hardly ever dealt with investors and their required structures.


add to this, the cultural aspects of it. eg asian background people (includig myself) have been raised with 'ownership mentality'... i.e buy something.. pay it off asap and own it.. dont carry debt...i must confess this was my mentality until i was shown the 'light'...

so P&I is good because it is easier to see the amount owing and watch it dwindle down versus an increasing offset account which doesnt necessarily mean a reduction in owing principle to some.
 
Not all banks automatically roll over IO debt. It can be a bit of a trap, especially if since you got the IO loan you have further loans causing serviceability issues, and or the lender changes their calculators/policies...
 
do you get charged a fee (if so, is it a big one) for effectively moving the money from the offset/redraw account over to kill the loan & own outright?


There can be early termination / exit fees depending on the loan (can be a few grand), particularly if you are paying it off in 1~5 years. Depends on the bank/product. We've done something similar where we owe a few dollars, but are not paying the loan off until the end of the "early kill" period.

Cheers,

The Y-man
 
dont think it has been mentioned, but if were comparing PI basic variable against IO std variable to get offset, then there will be an extra ~0.5% or whatever being paid p.a. with the IO/offset route over the PI basic variable loan.

definately IO/offset advantageous if you're unsure you're going to live in that place for rest of life and may want to turn it into IP later
 
I only use IO LOC's, but with the purpose (and disclipline) to pay down debt aggressively anyway (the only problem with P&I loans per se is they are often limited in how you can use them - less redraw etc).

P&I is frowned upon as a strategy in most discussions about property investing.

I can't understand this argument. Well, actually I can - the idea is that the interest is tax deductible and eventually the property is worth way more than the loan, so the risk is decreased and the cost of money decreases, and it increases you cashflow by not having to pay principle as well.

But, it's still interest, and you don't get to deduct the full 100% of it. It is excess money you have to spend in order to get rich quick - and it slows your getting rich plans down.

Why?

1. Because the properties are only going to appreciate at whatever rate they do it, regardless of your debt level. If the growth rate is slow, and you don't pay down debt, then you get rich slower. You can increase your equity (wealth) much faster by paying down the debt and get the double-whammy if the property booms in value.

2. IO loans improve the cashflow in the very short term, but their real value is in the longer term. You are paying interest on the amount still owing, and it is calculated DAILY. The more principle you pay, the less interest you owe, so your repayments decrease with IO loans. You cashflow increases each month you pay down some debt.

3. It's a "hidden return". The interest is costing you say, 6% (and someone will respond here with; "Oh, but I'm only paying 5%" :rolleyes: - please don't; it's a figure for the sake of the argument). So you are being paid 6% on the money effectively every time you decrease the interest, and it's not taxed.

The argument against all this is that you can get a better return on the money you would use to pay down the debt by investing it somewhere else. This can be true.

But if you know how to get a better return from that money than Property can provide, why bother with property at all? Most people haven't got the skill and/or knowledge to achieve that. You can only operate with what you know.

And finally, it makes it easier to buy again if your LVR is lower and you need to borrow more funds. Banks like to see savings records and solid financials now (and always - shock horror!). Continually buying on 95% LVR's etc is very difficult to do, also very risky, and the cashflow would be bad unless you are a very high income earner who is buying well below their maximum DSR level. But this rarely happens. Most people borrow as much as they can get. I never hear of people applying for a 60% LVR loan. ;)

So, by paying down the debt sooner, you get the best of both worlds; safer financial position, and an accelerated ability to keep on buying and increasing your "footprint" in the market. The more properties you have spread around the place, the more "diversed" you are from areas "stalling", and the quicker your overall wealth increases.
 
that is all assuming you dont have the willpower to keep what would otherwise be the principal payments, in an offset and hence paying the same interest anyway (well 0.5% or whatever extra to get offset option) given you'll put what would otherwise be principal payments into the offset. leaves door open for turning it into an investment and moving all money to non-deductible debt such as a new PPOR.

if you're sure the PPOR you're buying will remain so for 30+ years, then PI makes sense, but not everyone has that certainty
 
But if you know how to get a better return from that money than Property can provide, why bother with property at all?
Marc, this is exactly the point! It's precisely because property returns better than 6% on your equity that you wouldn't want to pay down your debt, but instead use extra cash to purchase more property.

If you have an interest payment of $1,000 per month and pay principal of $500, you're not investing $1,500 in property; you're investing $1,000 in property and $500 in cash. If the debt is deductible, it's the same as earning 6%/(1- marginal tax rate), ie around 9%, on that $500. So you're effectively investing $1,000 in property and $500 in a 9% cash management account.

If you instead save that $500 and use it as a 20% deposit on a further property, you should be able to get a much higher return than 9% (averaged over the life of ownership, not each year).

If you use a $20K deposit to buy a $100K property (keeping the maths simple ;)), then a 9% return on the $20K would require you to make a profit of $1,800 per year. Ignoring other holding costs besides interest, this means that when you add in $4,800 for 6% interest on the $80K you've borrowed, your total return on the property - rental income plus capital growth - only has to be $6,600, or 6.6% - in order to be better off buying more property rather than paying down debt.

If you can't get rent + CG to average more than 6.6%, you're not trying. ;)

I'm not suggesting everybody should go to max LVR; it depends on individual cashflow, market circumstances, risk profile, etc. My point is that from the perspective of return alone, paying back principal just is not going to perform as well as leveraging into more property over the long term.

I know you're a smart guy; I don't know why we're having this discussion again. By all means, pay down debt if it makes you feel more secure, allows you to borrow, etc - but don't try and tell me that it enhances your returns, because it just doesn't. :p

Back to where we started...
But if you know how to get a better return from that money than Property can provide, why bother with property at all?
You make my point very well... why would you borrow at 6% to buy any property if you don't think you can get a better return than 6.6%?
 
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