Can anyone give me information on interest only loans? We are thinking of using these as a strategy for investing in cash flow property but are a little unsure of what happens with them.
for example how do you reduce your principal? Is it an effective strategy for investing? Any help woule be greatly appreciated[biggrin]Time will reduce your principal.
I use the example of my parents home bought in the mid 70’s for $47000 on waterfront in Sydney. Had they paid IO all through the term of the loan then they would now have a debt of $47K against a $3M valuation.
Had that been an IP then they would have been able to free cashflow to buy additional property.
I use an analogy of explaining multiple IPs.
Imagine a property is an empty glass. The water represents your share. A new IP with a 5% deposit will be a new glass with a splash of water in the bottom.
Each year as the value grows the level of water will increase slightly.
Every now and then there is a storm and the level rises fast. That is a boom like we experienced recently.
Now in order to make best use of the boom we should have as many glasses out there as possible to catch this water. Going IO allows us to maximise the number of glasses.
We all have a mindset of paying down a loan when we buy a home. Many of us carry that into the IP game. We understand that debt is bad and we should pay it out ASAP.
This is not the case with deductible debt or good debt. By all means pay down your personal debt (non deductible) car loans, home loans, credit cards etc. But consider leaving the Good debt to run and using the principal to buy more investments.
Hope this helps explain things a little.
Simon Macks
Residential and Commercial Finance Broker
[email protected]
0425 228 985Comments may not be relevant to individual circumstances. If you intend making any investment, financial or taxation decision you should consult a professional adviser.
watch out for evaporation. Dry periods can be long and harsh!
[hmmm]
I currently have interest only loans on all my properties that allow me to make extra payments and lump sun deposit with no penalty if required.
Why would consider Principle and Interest loans when you have a facility like this available to you
Cheer
Paul
I
Paul Meese
Onyx Finance
[email protected]
0412 850 820G’day all
I am also interested in finding out what these Interest Only loans are all about.
Simon (Mortgage Hunter) I go back to your example of your parent’s place.
So they paid interest only (hence their mortgage payments were smaller each month) and now they still owe the initial borrowed sum of $47,000. Will this sum then be paid out when they sell the property? Are you under any time frame to come up with this sum or will the bank just wait until you want to sell it?Now, if they had paid Interest and Principal does that mean they would now owe $0 on the property – so the full $3Million would be theirs? (ie you don’t have to subtract the $47,000 from the $3Million if you sold the property). But by paying interest and principal over those years the draw back was paying a higher mortgage payment each month which then (could have) meant they didn’t have as much cash lying about to finance other investment properties.
Is this logic I have applied correct? Is it a too simplified view to such a situation?
If the logic is on track….are we talking the same time frame for each of these scenarios? That is will you pay off all your interst only loan in the same years as you would an interst/principal loan – assuming you stuck to the minimum payments. If not which is quicker and why.Another question if these scenarios are vaguely right – isn’t it better to own your property outright at the end rather than still having to pay off the initial borrowed amount?
Also do you still choose if you want a fixed or variable interest rate for interest only loans? If so which is better – or is it a case of looking at what the market is doing and trying to pre-empt a drop/rise in interest rates.
Sorry for the overload of questions! Just trying to get the terminology and different options out there under hat!
Cheers
jxfIt would be better if you owned an asset outright, but by taking an IO loan the lower repayments over the years may enable you to buy many more assets multiplying you returns.
I would say the advantages of IO are:
1) lower repayments which allow you to invest in extra property/shares etc2) if on Investments, lower repayments allowing you to divert extra money to paying down non deductible debt.
Terryw
Discover Home Loans
[email protected]
Send an email to get my newsletter.Terryw | Structuring Lawyers Pty Ltd / Loan Structuring Pty Ltd
http://www.Structuring.com.au
Email MeLawyer, Mortgage Broker and Tax Advisor (Sydney based but advising Aust wide) http://www.Structuring.com.au
Originally posted by jxf:G’day all
I am also interested in finding out what these Interest Only loans are all about.
Simon (Mortgage Hunter) I go back to your example of your parent’s place.
. So they paid interest only (hence their mortgage payments were smaller each month) and now they still owe the initial borrowed sum of $47,000. Will this sum then be paid out when they sell the property? Are you under any time frame to come up with this sum or will the bank just wait until you want to sell it?Now, if they had paid Interest and Principal does that mean they would now owe $0 on the property – so the full $3Million would be theirs? (ie you don’t have to subtract the $47,000 from the $3Million if you sold the property). But by paying interest and principal over those years the draw back was paying a higher mortgage payment each month which then (could have) meant they didn’t have as much cash lying about to finance other investment properties.
Is this logic I have applied correct? Is it a too simplified view to such a situation?
If the logic is on track….are we talking the same time frame for each of these scenarios? That is will you pay off all your interst only loan in the same years as you would an interst/principal loan – assuming you stuck to the minimum payments. If not which is quicker and why.Another question if these scenarios are vaguely right – isn’t it better to own your property outright at the end rather than still having to pay off the initial borrowed amount?
Also do you still choose if you want a fixed or variable interest rate for interest only loans? If so which is better – or is it a case of looking at what the market is doing and trying to pre-empt a drop/rise in interest rates.
Sorry for the overload of questions! Just trying to get the terminology and different options out there under hat!
Cheers
jxfThis is an interesting post and one I am always trying to explain to people. Firstly let me say that there is no right or wrong. Consider what I have to say and make your own choices and remember I am not offering any investment advice. Just my viewpoint for discussion.
Our parents generation viewed debt as bad. They were influenced by the depression stories and had a goal of owning a home. Perhaps a beach shack too if they were wealthier than the average.
Are they the benchmark that you wish to compare your outcomes too? If so then I suggest that you are aiming for a lower middle class result. Noble but you can do better.
Typically IO loans are 5-10 years long at which stage they revert to P&I. They can be renegotiated to IO or a LOC can be used which is a permanent IO loan.
So a 30 year loan might be IO for 5 years to keep the repayments lower at your early stage of working life and the house will still be paid off in 30 years.
For an IP then only the interest is tax deductible. Not the actual principal repayment. So why have any non deductible costs on an IP? Who cares if you never own it? You own all the growth and own all the rent. Aren’t these the best bits?? [biggrin] I think this hang up with owning the property outright is a working class mindset – wealthy people actually own very little.
So IO is a lower repayment and fully tax deductible. The additional cashflow that this generates will allow you to invest further and generate more cashflow and CG.
If you only ever want one property then P&I is clearly the best strategy.
If you want to own multiple properties then IO will get you there sooner.
Simon Macks
Residential and Commercial Finance Broker
[email protected]
0425 228 985Comments may not be relevant to individual circumstances. If you intend making any investment, financial or taxation decision you should consult a professional adviser.
Thanks Terryw and Mortgage Hunter. Your explanations have cleared things up a lot! My main hesitation with what I understood about IO loans was the idea that after the interest was paid (in a short term say 5years) you had to pay up the lump sum of the principal. Your comment that there are loans that can be interest only for a period of time then divert to interest and principal is interesting. Since I am looking at holding on to my investment properties for many years I was initially not sure IO loans were for me but with the other option you described my eyes have been opened!
I have one more question… SORRY!
Going back to the cups catching rain analogy. Is it better to have a few large cups or lots of small cups to catch the rain. By that I mean is it better to by lots of cheaper properties (say properties in regional locations at about the $100,000 mark – which can be easier to positive geared). Or is it better to have only a few houses in the already substantiated suburbs? (So places worth .. roughly $250,000 plus).Cheers for your viewpoint.
jxfOnce again this isn’t a simple question and people will have had success using either.
I personally feel that you should choose areas that have a history of capital growth. Whilst many people made money out of remote towns in the recent boom some of these places had little growth in the 20 years preceeding what was the biggest boom in our short history.
Personally I prefer major regional centres or capital cities. But you need to research this fully yourself. Choose an area or a few areas and research them to death [biggrin]
All the best
Simon Macks
Residential and Commercial Finance Broker
[email protected]
0425 228 985Comments may not be relevant to individual circumstances. If you intend making any investment, financial or taxation decision you should consult a professional adviser.
Originally posted by jxf:I have one more question… SORRY!
Going back to the cups catching rain analogy. Is it better to have a few large cups or lots of small cups to catch the rain. By that I mean is it better to by lots of cheaper properties (say properties in regional locations at about the $100,000 mark – which can be easier to positive geared). Or is it better to have only a few houses in the already substantiated suburbs? (So places worth .. roughly $250,000 plus).Cheers for your viewpoint.
jxfHi jxf
I had the same question when I started researching suburbs 4 months ago. I am from a regional city but felt compelled to look to the cities. I have now decided there benefits and negatives in both so as my knowledge has grown so has the strategy that I will put into place. I have used Residex to help narrrow down suburbs but good old fashioned homework, which can be done on the net, is usually needed to check what is going on in an area (start with council websites and go from there). Basically I have decided that rather than buy a heap of cheap properties which some investors are doing, I will pursue a mix of both. Some cash flow positive cheapies from the lowest risk regional areas combined with some good metro prospects for capital gain. Hopefully the mix will even out in the wash somewhat and looking further down the track I may consider then selling the regional homes to pay out the good capital performers (I’ll cross that bridge when I get to it). The Australian Property Investor magazine has many interesting articles in it which can point you in the right directions for research, advice and inspiriation. Good Luck.Hi Jxf
You’ve has some very good input (particularly from Simon).
However, as he intimated given all the feedback you’ve been given, only you can make the best decision for you; and that depends on what your final goal is. This might be a better starting point to create your investment strategy.
For example, if you wanted to own your own place rather than becoming an investor then P&I might serve you well. Apart from what we know about good debt and bad debt, ownership and therefore paying loans down fast was very important to the previous generation. Their goals may have been based on ownership rather than investment.
On another tangent, do you have a plan that goes beyond your lifetime – ie your children, or nephews/nieces, etc. Who will you be leaving your ‘property empire’ to? If you never own these properties, and you leave it to the next generation, what capital gains tax liability could you be imposing upon them when they sell?
We have history to tell us that we think a lot differently in terms of investments and debt, than our parents did. It would not be unusual for the next generation to react as we may have done.
One final thought. This is not a for or against interest only loans but just a ‘devil’s advocate’ position. “Interest only” is the traditional wisdom for today, but some investors will argue that fortunes can also be made by not following the ‘herd’. Also you may optimise your capacity to buy more properties with IO, but if you are geared to the hilt and interest rates increases impact you further, you may wish you still had the safety net. Having said that, I think someone has already spoken about IO with an offset account/potential to pay principle sums anyway.
Gary
Author of “Property Millionaire, The Guidebook to Having Great Australian Dreams”
Creator of Property Millionaire – The Boardgame
http://www.888abundance.comi am nowhere near as experienced as all of these guys but the way i look at the I.O. vs P+I scenario is like this:
say if i buy a house for 100,000 and then sell that house for 175,000 in 5 yrs time creating a 75k capital gain.
If i had the loan set up as P+I i may have paid 50,000 off the principal. So i would receive a “profit” of 125k when i sold it……….. but in reality the extra 50k i paid off the principal is just my money being returned to me…..its kinda like saving 50k in the bank. in that 5yrs i could of just paid the interest on the loan and put that 50k into other investments and made further profits rather than it sitting on my mortgage doing nothing.
thats my simple way to look at it….coming from a simple mind (who failed maths in grade 10) hehe.
Originally posted by 65ens:i am nowhere near as experienced as all of these guys but the way i look at the I.O. vs P+I scenario is like this:
say if i buy a house for 100,000 and then sell that house for 175,000 in 5 yrs time creating a 75k capital gain.
If i had the loan set up as P+I i may have paid 50,000 off the principal. So i would receive a “profit” of 125k when i sold it……….. but in reality the extra 50k i paid off the principal is just my money being returned to me…..its kinda like saving 50k in the bank. in that 5yrs i could of just paid the interest on the loan and put that 50k into other investments and made further profits rather than it sitting on my mortgage doing nothing.
thats my simple way to look at it….coming from a simple mind (who failed maths in grade 10) hehe.
Analogy is great.
But your figures are hopeful. I suggest you would have only made a $5K dent in the P part of the loan in that time …
All the Principal repayment action happens in the later years of the loan!! [blink][blink]
Simon Macks
Residential and Commercial Finance Broker
[email protected]
0425 228 985Comments may not be relevant to individual circumstances. If you intend making any investment, financial or taxation decision you should consult a professional adviser.
HI Jxf
The interest only period may be set for a period of years say 5 for example, some loans it can be for the life of the loan. However returning to say the 5 yr I/O period that does not impact on the overall life of the loan.Eg if you take out a loan for 30 years and you choose to make the first 5 years interest only, it means that for the first 5 years you will pay nothing off the principle. However after that you will start paying of as a P/I loan for the remainder unless you make an adjustment. In other words once you have gone over that 5 years you will start reducing your loan amount, your repayments will increase to cover principle and interest .
Wayne
Mortgage Adviser
Email [email protected]
http://www.alphamortgagesolutions.com.au
First home buyers, investors, refinace, loan consolidation, equity loans, free service we come to you!Originally posted by Mortgage Hunter:Originally posted by 65ens:i am nowhere near as experienced as all of these guys but the way i look at the I.O. vs P+I scenario is like this:
say if i buy a house for 100,000 and then sell that house for 175,000 in 5 yrs time creating a 75k capital gain.
If i had the loan set up as P+I i may have paid 50,000 off the principal. So i would receive a “profit” of 125k when i sold it……….. but in reality the extra 50k i paid off the principal is just my money being returned to me…..its kinda like saving 50k in the bank. in that 5yrs i could of just paid the interest on the loan and put that 50k into other investments and made further profits rather than it sitting on my mortgage doing nothing.
thats my simple way to look at it….coming from a simple mind (who failed maths in grade 10) hehe.
Analogy is great.
But your figures are hopeful. I suggest you would have only made a $5K dent in the P part of the loan in that time …
All the Principal repayment action happens in the later years of the loan!! [blink][blink]
Simon Macks
Residential and Commercial Finance Broker
[email protected]
0425 228 985Comments may not be relevant to individual circumstances. If you intend making any investment, financial or taxation decision you should consult a professional adviser.
of course…i was just trying to use simple figures to demonstrate the point i was trying to make.
“..its kinda like saving 50k in the bank. in that 5yrs i could of just paid the interest on the loan and put that 50k into other investments and made further profits rather than it sitting on my mortgage doing nothing.”
That statement sums up the typical complete ignorance over interest only loans and why banks love people who taken them. The capital payments don’t “do nothing” they reduce your interest payments, so they are making money at the interest rate, totally tax free.
Consider this: If the interest rate is 8%, every dollar you put onto the home is making 8% PA Tax free. This is because you don’t pay interest on it which is 8% of what you owe. So unless you can use that money to make more than 8% PA after tax and all expenses, putting in onto the house is BEST investment you can make.
Consider an investment house that doubles in 10 years, thats 8% PA increase. Now consider all the costs you have paid, all the tax etc. The profit is typically between 2% and 5% PA. Where as you could have not had that extra investment at all and make 8% buy paying off your loan.
“Say if i buy a house for 100,000 and then sell that house for 175,000 in 5 yrs time creating a 75k capital gain.
If i had the loan set up as P+I i may have paid 50,000 off the principal. So i would receive a “profit” of 125k when i sold it……….. but in reality the extra 50k i paid off the principal is just my money being returned to me”Wrong. You would have saved 8% each year on the money you put into the house. For example if you just lump payment $50,000 when you got the loan, obviously that would save you 50% of the interest you paid over those 5 years (about $20,000!). But if that $50,000 is paid grandually over the 5 years the result is probably a saving of about $10,000 or so. Either way the saving is 8% per year tax free. No way would another investment house get that much! INterest only is CRAZY, please do the math, unless you can someone get an awesome negative gear than it *might* be better but in most cases , NO NO NO NO NO!!!
Originally posted by dacium:“..its kinda like saving 50k in the bank. in that 5yrs i could of just paid the interest on the loan and put that 50k into other investments and made further profits rather than it sitting on my mortgage doing nothing.”
That statement sums up the typical complete ignorance over interest only loans and why banks love people who taken them. The capital payments don’t “do nothing” they reduce your interest payments, so they are making money at the interest rate, totally tax free.
Consider this: If the interest rate is 8%, every dollar you put onto the home is making 8% PA Tax free. This is because you don’t pay interest on it which is 8% of what you owe. So unless you can use that money to make more than 8% PA after tax and all expenses, putting in onto the house is BEST investment you can make.
Consider an investment house that doubles in 10 years, thats 8% PA increase. Now consider all the costs you have paid, all the tax etc. The profit is typically between 2% and 5% PA. Where as you could have not had that extra investment at all and make 8% buy paying off your loan.
“Say if i buy a house for 100,000 and then sell that house for 175,000 in 5 yrs time creating a 75k capital gain.
If i had the loan set up as P+I i may have paid 50,000 off the principal. So i would receive a “profit” of 125k when i sold it……….. but in reality the extra 50k i paid off the principal is just my money being returned to me”Wrong. You would have saved 8% each year on the money you put into the house. For example if you just lump payment $50,000 when you got the loan, obviously that would save you 50% of the interest you paid over those 5 years (about $20,000!). But if that $50,000 is paid grandually over the 5 years the result is probably a saving of about $10,000 or so. Either way the saving is 8% per year tax free. No way would another investment house get that much! INterest only is CRAZY, please do the math, unless you can someone get an awesome negative gear than it *might* be better but in most cases , NO NO NO NO NO!!!
I agree.
But only where you have finished buying properties and are in a consolidation (paying off) phase.
If you are still accumulating and wish to own mulitple properties then P&I should only be considered on your PPOR.
Cheers,
Simon Macks
Residential and Commercial Finance Broker
[email protected]
0425 228 985Comments may not be relevant to individual circumstances. If you intend making any investment, financial or taxation decision you should consult a professional adviser.
I think this also flows over to people who talk about renting a house while buying an IP. Sure you will own the IP cheaper this way, but with capital gains tax you will actually come out behind someone who just brough and lived in the house. Many peopel seem to have this backwards (the assumption that an invester will make more out of a house than a principal residant can, when all taxes are considered this is almost NEVER the situation).
Dacium
Never?
What about if someone were to live in their rental property briefly, then rent it out and they rented somewhere else. They could claim the CGT exemption and still get the tax benefits of negative gearing their main residence while paying lower rent. In my calculations this person would be ahead in early years. Later on as rents rise the deductions will decrease, and then it will be time to move back home.
Terryw
Discover Home Loans
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Send an email to get my newsletter.Terryw | Structuring Lawyers Pty Ltd / Loan Structuring Pty Ltd
http://www.Structuring.com.au
Email MeLawyer, Mortgage Broker and Tax Advisor (Sydney based but advising Aust wide) http://www.Structuring.com.au
There are some exceptions, like you said with livining in a rental.
But I would check with your tax man to make sure you are doing it correctly. The reason for this is because if you don’t pay GCT you are liable to pay back all tax you have deducted over the years as a ‘loss’ on an investment house that didn’t end up being classed as an investment, and you will have to pay the money back with interest.
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