Sorry if this is a straightforward question but I can't seem to find a definitive answer anywhere.
It concerns the minimum repayment amount on a P&I loan with a 100% offset account.
I understand that the offset amount effectively reduces P&I so that interest on the loan only accumulates on the balance.
So far so good.
What I don't know is this:
Is the offset taken into account each month when determining the minimum repayment amount? i.e. Can the offset reduce the minimum repayment?
OR
Is the minimum repayment amount pre-calculated and fixed without taking the offset into account, so that even if the amount in the offset account is equal to the principal the lender still forces you to paying down the principal?
I am asking this because I'm (a) thinking of getting an interest only loan, but (b) concerned about what happens when the IO loan term ends and the loan becomes P&I. Will the minimum repayment per month on a 300K loan suddenly rise from a few hundred dollars to a couple of thousand regardless of how much I have sitting in the offset account?
Alternatively, how simple or difficult is it to re-finance with a second IO loan once the first ends?
Thanks for any help.
As often the case my very next search after posting this yielded some answers…
It seems that certain offset accounts allow monthly repayments to be reduced while others reduce the principal and the loan term and eligibility may depend on whether the property is PPOR or investment.
Wish the lenders would be clearer about this.
Sorry for the waste of space
James,
If you are getting into investing there is no need to understand P&I, in fact it should be a dirty word. I have never met anyone who became wealthy by paying their home off. All value / wealth is achieved by allocating any available cash-flow into another appreciating asset. The key question is: How do I increase cash-flow and how do I attain more assets? While answering both of these questions you will find paying money into a loan achieves very little – correction, it gives 99% of Australia a warm feeling when they open their bank statement. But financially it has no bearing on your wealth.
What P&I achieves : Smaller tax deduction if the property is to be rented in the future, reduced capacity to pay for another investment property, and money locked inside a loan that you have to pay a fee to the bank if you were after an advance on your loan……………
The key theme, is that you then have to be disciplined with your increased cash-flow. But you would not be in this game if you have NIL financial discipline.
Thanks for replying.
I understand the cash flow benefits of IO over P&I.
I do think I will be able to find a loan with an offset account that reduces monthly repayments, which is great.
The reason I'm concerned is that frankly I'm not sure about my employment status, so having the ability to keep repayments low is very attractive. I do have significant savings to put into an offset, however, which is a bit unusual so I've had an interesting time trying to get my head around various appropriate strategies.
IO appears to offer more flexibility, but I could easily get into a difficult situation if I purchased something expensive requiring a big loan that stings me once the IO loan reverts to P&I and the repayments spike. It might be difficult to service the loan and force me to do something that might not be in my best interests at that time. (Who can predict the future?) The market could also tank and affect LVR, so there's a greater than zero risk there, too.
However, the alternative conservative options (e.g. putting more equity into the property, making a small and safe purchase with less potential for capital gain) seem counter-productive for the reasons you suggest.
And to get back to my point about lenders – these decisions are tough enough to mull over without the lack of description and transparency and ease of comparison between the multitude of options for things like offset accounts!
You may be missing my point?
P&I should never be used, hence there is no need to ask the question – I am a Broker an Planner and I do not want to know what banks have the policy that you are describing. All my clients are I/O. If the bank doesn,t allow this, then take your business to another who will. There are many options when you think like the masses, but when you calculate the numbers for what they are, you have limited choices. It is very simple when you know where to look?
So what do you advise your clients to do once their IO loan reverts to P&I after the 5 years or so are up?
I understand there's a good chance the IO loan can be extended, but what if the bank decides they are no longer eligible? It'll revert to P&I…so surely it makes sense to understand the potential risk that might be involved with that possibility?
Most of our our IO loans are for a minimum of 10 years.
Richard Taylor | Australia's leading private lender
number 8 wrote:You may be missing my point?P&I should never be used, hence there is no need to ask the question – I am a Broker an Planner and I do not want to know what banks have the policy that you are describing. All my clients are I/O. If the bank doesn,t allow this, then take your business to another who will. There are many options when you think like the masses, but when you calculate the numbers for what they are, you have limited choices. It is very simple when you know where to look?
Number 8 – how can you say P&I should never be used?
Planners should be working towards the clients goals not their own ideals. Some people may want to reduce their level of gearing as they get older – especially if they have strong incomes. I have a client who has no personal debt and refuses to have investment loans with terms longer than 10 years. Half of his titles are in a safe at his house and he has a company returning him 750k p/a. If you told him he had to keep his debts interest only he would laugh you out of the room.
I agree it is not everyones cup of tea and each client is different.
I personally have over half of my properties on a P & I basis and the other half own unencumbered.
To me the gross rents of the unumbered ones go into paying down the principal debt of those still mortgaged.
This may not be the advice i give the average client after listening to their requirements.
Richard Taylor | Australia's leading private lender
Hi James,it's perfectly normal to think and research the worst case scenario and then try and plan for it.Our IO loan was only 5 yrs standard bank policy and our IP needed some major work so i renegotiated the loan,but could only get 5yrs.Have since found some lenders do 10 yrs as Richard mentioned.With most lenders you can still pay in extra on IO.We once had some extra $$$ paid it in to our IO account reduced the principal then redrew it later for a deposit on an IP.So IO doesnot always mean interest only.ANZ used to have a policy where you could put a min of 500 extra in upto amax of 10k per annum,but believe they have waived this now.Each lender has slightly different criteria.Good luck ;do your research ,due diligence,manage your risk,do the numbers,it is a big step Al
Banker wrote:number 8 wrote:You may be missing my point?P&I should never be used, hence there is no need to ask the question – I am a Broker an Planner and I do not want to know what banks have the policy that you are describing. All my clients are I/O. If the bank doesn,t allow this, then take your business to another who will. There are many options when you think like the masses, but when you calculate the numbers for what they are, you have limited choices. It is very simple when you know where to look?
Number 8 – how can you say P&I should never be used?
Planners should be working towards the clients goals not their own ideals. Some people may want to reduce their level of gearing as they get older – especially if they have strong incomes. I have a client who has no personal debt and refuses to have investment loans with terms longer than 10 years. Half of his titles are in a safe at his house and he has a company returning him 750k p/a. If you told him he had to keep his debts interest only he would laugh you out of the room.
Thank you for prooving my point………
As you have mentioned you have a client that has a company returning $750,000 per annum (well lucky him) if you couldn,t pay off a home in one year then we all would laugh "rich guy" out of the room – it's not rocket Science for "rich guy" to make money? We are establishing a strategy for the average Australian and I don't know anyone who has a $750,000 income. To use him as an example is ridiculous. As a rule, people do not have incomes of $750,000 or twenty to thirty properties that provide rental returns equivalent to a persons income over a lifetime. One thing I have picked up on this website is how the people giving advice always play the card, "I know a wealthy person that creates wealth like…….." or there is a lot of sound advice based on making money if you have a lot of assets or a very large income……. The real finance game is about making money for and from the income of a Teacher, Nurse, Electrician, Plumber, Salesperson, Photographer, and Banker i.e. the typical Australian. How many typical Australians can pay down a debt like our "rich guy"?
You cannot play this game by starting with the rules on the rich side of the island, you have to play with the cards you are dealt, then you can play with the rules on the rich side of the island. (Pick the father with kids watching Madagascar?) i.e. Accrue the assets first, and to accrue assets you must have cashflow. Once cashflow is excessive ("Rich guy") can then pay down debt and laugh me out of the room…………..
Work with the numbers of the real person and you will quickly see you should NEVER pay down your debt vs purchasing an investment property with the extra cashflow. To re-iterate my first comment, Please read below the statement I made earlier:
What P&I achieves: Smaller tax deduction if the property is to be rented in the future, reduced capacity to pay for another investment property, and money locked inside a loan that you have to pay a fee to the bank if you were after an advance on your loan……………The key theme, is that you then have to be disciplined with your increased cash-flow.
THIS MEANS USE AN OFFSET ACCOUNT – AKA – YOU ARE PAYING THE SAME AMOUNT AS A P/I LOAN ALTHOUGH YOU ARE PAYING I/O……………………..
So before anyone gets excited any further it must be understood that in principle, the same repayment is made but into an offset account………..except there are three great big benefits as mentioned above! Strategies have to help the average person with an average income. Lets face it, half the strategies I read on these websites are for very wealthy people and the advice is generally from very wealthy people with there own interests at heart. I write this as I see Steve McKnight's Advertisement roll over on the right of this page………
James, Getting another 5 year I/O is simple, if not, take your business elsewhere. No risk here!
For the record, just b/c one utilises I/O this does not mean you should take a larger loan. I would never encourage this behaviour.James, if you work on your worst case scenario and the bank makes you pay P&I. You have be doing this in your offset account for the last five years. No risk here!BANKER : Ideals – existing in the mind or imagination. Please do the numbers?????? Sorry but I only deal with facts. I will leave it up to your ideals to show me how paying off one property (P&I) can outperform purchasing two properties using (I/O). Remembering the I/O repayment on the first property increases your cashflow to make repayments for the second property ??????
Nice come back number 8 however not everyone wants to keep buying. Everyone has different goals. Once you’ve paid down personal debt their is nothing wrong with amortising investment loans.
Also some people can't help themselves with spending. If they have access to cash they spend it, so for them PI loans are a form of forced savings.
But I agree that you should only use a PI loan on an investment when you have no personal debt left
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
Can I clarify something then? I have no personal debt, I have a P&I loan on our first IP and are looking to set up to buy our second IP. Should I continue with P&I loans if I can afford the full repayment?
Thanks
Mark
I would personally still use IO loans with a 100% offset account attached.
Because:
– money paid into a loan cannot be taken out without tax consequences
– you will still save the same interest as using a PI loan
– your repayments will be lower meaning you can afford more investments
– your repayments will be lower which will help if you get short of funds
– you can always pay extra on most IO loans if and when you chose to.But if you are temped to spend the cash that will build up in the offset account you may be better with PI
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
Terryw wrote:I would personally still use IO loans with a 100% offset account attached.Because:
– money paid into a loan cannot be taken out without tax consequences
– you will still save the same interest as using a PI loan
– your repayments will be lower meaning you can afford more investments
– your repayments will be lower which will help if you get short of funds
– you can always pay extra on most IO loans if and when you chose to.But if you are temped to spend the cash that will build up in the offset account you may be better with PI
I completely agree…
Mark – Terry has a point re offset has benefits. My point above and I think Terry’s is that one glove dosnt fit all people and it depends on future goals amongst many other things.
Another thing no one has touched on is servicing. Some banks will assess deals on a 30 year term. If you apply for 5 years IO then 25 years PI banks will often assess capacity to repay over 25 years.
E.g. Cba calculator
income 80k one adult, no dependents. No other liabilities
max loan 30 years $487,784
max loan 5 yr I/O then 25 p+i $421,729
max loan 10 yr I/O the. 20 p+i $286,306With this in mind lender selection will also impact what is best for you. Your choice of lender may be more important to you than keeping your debt I/O… E.g they might be 0.5% cheaper.
Also a loan of 300,000, pi, 6%, 30 years, will have a balance of approx 279k after 5 years. The 21k difference is usually not in the offset for interest only clients. 10 years in banking tells me most people spend it.
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