Hi everyone,
This is my first post. I’m interested in starting PI. I’ven been reading books on PI and have found that most investors advise getting interest only loans. I understand the concept is that since payment on principal are not tax deductable, it’s best to maximise cahflow by not paying it. But how does it actually work. Does one only pay interest on the loan indefinitely? If the pricipal is not paid off, does that mean that interest accrues all the time? How would the property ever become unencumbered?I’m sorry if this thread has been discussed in this forum previously. I’ve been reading through most of the legal, accounting and finance threads, but have not found anything that cleared the question for me.
Thank you in advance.N
Hi Ninie
Consider this. Say you bought a house 20 years ago for say $60,000, you borrowed 80% or $48,000. You only pay the interest on the loan, not the pricipal. Today, you still owe $48,000 but the house is worth $300,000 and you get $350 a week in rent. Although you haven’t paid anything off the principal, it has decreased relative to the value of the home, and, as you have mentioned you’ve had the extra cash flow for other investments and all repayments are tax deductible.
If you’ve picked up on the difference between “good debt” and “bad debt” and can see the benefits of leveraging your money, you can see why investors are trying to maximise their loans (getting equity loans when a property goes up in value) rather than minimising their loans by paying off the principle.
Generally with an IO loan, if it’s not fixed interest, you can make extra repayments which come off the principle, thereby reducing your interest payments. You can then redraw those extra payments as needed (for investment purposes only).
Or again, you have an offset account to reduce the interest repayments, then there are no tax issues if you use the money for non investment purposes.
What I mean by leveraging your money is if you have loan of 80% on a house and that house goes up in value by 20% in a given time period, you have effectively doubled your invested capital (ie, house costs $100,000, you have $20,000 of your own money in it and the bank has $80,000). Value goes up by 20% to $120,000. You still only owe the bank $80k so you now have $40k in equity.
If you used all your own money and bought a house for $20,000 and it went up by 20%, you’ve only increased your equity by $4,000
I hope that’s no thoroughly confusing.
Kudos to Oshen on a fantastic detailed reply,
Cheers.Regards
Steven Crane
Mortgage BrokerMobile Mortgage Market
Ph: 0402 483 216
[email protected]
http://www.mobilemortgagemarket.com.auPLEASE note comments made should not be taken as specific taxation, financial, legal or investment advice.
Hello Mobile Mortgage and Oshen,
So do most investors set up their loans as IO (indefinitely) with an offset account attached to it?
Thanks in advance.
JP
Hi JP & welcome to the forum,
It’s hard to say what most investors do, but the majority of my clients do have their investment loans structured as interest only.Regarding your offset question, I would hazard a guess that the majority don’t use an offset, but I believe the offset will become more popular with investors as they become aware/educated of the benefits that a 100% offset account may offer over a LOC for instance.
Of course what is best for One may not be appropriate for another, as always individual circumstances will be the deciding factor when choosing the correct structure lender and product, Cheers.
Regards
Steven Crane
Mortgage BrokerMobile Mortgage Market
Ph: 0402 483 216
[email protected]
http://www.mobilemortgagemarket.com.auPLEASE note comments made should not be taken as specific taxation, financial, legal or investment advice.
Hi Oshen,
Thank you very much for your very detailed reply. I understand that the amount of the loan over time would diminish percentage wise in relation to the value of the home. But what about if I’d like to one day actually own the home? say after 20 years of doing PI and getting a few +ve cashflow properties, I’d like to retire and not have to worry about having debt (even one that is being paid for by tenants), is the logical thing to do then sell a few and use the proceeds to settle the principal of the majority?
What is the usual duration(year) of IO loan?
Thanks!
NHi Niniebear
An interest only term will vary between lenders 5 to 15 years etc and then revert to a P&I loan for the remainder of the 25-30 year term, or at the end the I.O term you could negotiate or refinance to another I.O term,As Oshen mentioned most lenders allow you to make extra principle repayments with an IO product, however maybe a P&I loan would suit you best it all depends on your individual circumstances,
Keep in mind I.O repayments may provide you with more funds to service further debt and hence acquire more investments, Cheers.
Regards
Steven Crane
Mortgage BrokerMobile Mortgage Market
Ph: 0402 483 216
[email protected]
http://www.mobilemortgagemarket.com.auPLEASE note comments made should not be taken as specific taxation, financial, legal or investment advice.
Thanks for the info MM
I have been reading this forum for a couple of months now – its really good for getting help, especially with you guys posting here.
Thanks Jaypee, it’s a pleasure,
Its always nice to know we are appreciated, have a great weekend cheers.Regards
Steven Crane
Mortgage BrokerMobile Mortgage Market
Ph: 0402 483 216
[email protected]
http://www.mobilemortgagemarket.com.auPLEASE note comments made should not be taken as specific taxation, financial, legal or investment advice.
Best loan structures….
Investment Property – Interest Only Loan with Offset
PPOR Property – Interest Only Loan with OffsetThere is no other choice in my mind for those buying property and wanting flexibility!
TMA
http://www.email4money.info
Essential Links
First Home Buyer WebsiteTMA
Forgive my ignorance mate but is offsetting basically having an amount of money (say $10k) in a separate account but the interest that the $10k would normally earn just comes straight off the loan interest amount instead?? hence more of the fortnightly loan payments is principal??
What are the major pro’s and cons of this type of setup??
Cheers mate
Coops
Coops
That is it.
The major Pro is that is retains the original loan amount if the funds are used. This will be significant if the loan is deductible and you wish to use funds for personal debt- the original loan is untouched and may still be claimed.
A quick explanation but you will find a lot of stuff on it if you do a search.
Cheers,
Simon Macks
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 CoopsT:…is offsetting basically having an amount of money (say $10k) in a separate account but the interest that the $10k would normally earn just comes straight off the loan interest amount instead??
Sort of…
The Offset Account is linked to the loan account. If you had the 10K sitting somewhere else, you might be earning 5.40% on this money. You would also have to pay tax on the income.
If you put the same 10k in the offset attached to your PPOR and your loan was 6.75%, it would be the equivalent of earning 6.75% tax free on this money. If you were in the highest tax bracket, ths is around 13% return before tax.
The second that 10k hits your account, the principal amount is reduced, not the interest. For example, if your loan is 100k, with the 10k in the offset account, it would be calculated as though the loan is 90k (but in reality it is still 100k assuming you are only making interest only payments to the actual loan). Interest on 90k is a lot less than interest on 100k.
You can also take the 10k out at any time and the interest will just be calculated on the 100k again.
hence more of the fortnightly loan payments is principal??This only occurs if you make the same P&I payment every month. I still suggest only making interest only payments as it has the same effect if the money is sitting in your offset account or in the loan. The difference is, once in the loan, you lose some tax benefits later if you change a PPOR into an IP.
What are the major pro’s and cons of this type of setup??As far as I am concerned, there are no cons to using a properly structured loan with offset account. Regarding using a LOC, I will just give you two cons…. HIGHER COST & LESS FLEXIBILITY!
TMA
http://www.email4money.info
Essential Links
First Home Buyer WebsiteSo lets say I have an I/O loan of $100,000 with an offset facility.
I win $100,000 in the lottery (wishful thinking), and deposit it in the offset. So now I am not paying any interest.
If I decide to discharge the loan, do they (the bank) just keep the money in the offset and everything is square (less discharge fees etc), or do I have to withdraw the money from the offset and then pay it?
Hi Jaypee
Yes, if you want to eventually own the house, you just pay off the principle.
Investors don’t tend to do that though as they are interested in getting the best returns from their money. That’s why you borrow in the first place.
Think about the return you would get from owning a house outright. If it’s your $300,000 in the house, your return might be 3% or so. If you only have $60,000 then your return could be 8 or 9% plus you have $240,000 invested elswhere at another 8 or 9%.
So, compare a passive income of $9000 with $24,000pa before you decide whether or not to pay out investment loans.
Someone feel free to correct my math if I’ve completely stuffed that up. I’m a bit tired.
With regard to the notion of “owning” a house, I’m not sure that ever happens. Just stop paying the rates for a couple of years and you’ll find out who really owns “your” house.
Investment properties and loans are simply a vehicle to make money, that’s all. For peace of mind and security pay off your PPOR by all means, but paying off an investment property is sort of defeating the purpose. That’s providing it is not heavily negatively geared.
You have to transfer the funds from your Offset Account. They cannot just take it. An Offset Account is a name given to a transaction account when it is linked to a loan and offsets the interest on that loan when funds are parked in it.
TMA
http://www.email4money.info
Essential Links
First Home Buyer WebsiteTMA…who would you recommend as the better lenders for IO loans on PPOR??
Nat, it is very hard to recommend anyone. It depends on loan features, loan amount and loan purpose.
Most lenders have great IO loans.
TMA
http://www.email4money.info
Essential Links
First Home Buyer WebsiteAll my loans are interest only. Yes interest is calculated everyday and you will never pay the property off.
This is not so bad. It’s all about timing.
With the money saved in not paying back the loan, you can purchase other properties that will grow. Then after some time 5/10 years or less, depending how the property marked is performing, you could sell some to pay the others off completely.
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