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interest loan

Discussion in 'Finance & Banking' started by navjit6, 10th Nov, 2009.

  1. navjit6

    navjit6 Active Member

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    can you have an IO loan with an offset account? i.e. 280k loan, 20k in offset.
    does that mean you pay interest on 260k? if yes, and you continued to increase the amount in the offset account, would this continue to decrease the interest payments?
     
  2. Simon Hampel

    Simon Hampel Co-founder Staff Member

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    Yes to all questions.
     
  3. navjit6

    navjit6 Active Member

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    what are the main benefits of IO loan that makes it better than P+I loan for IP's?
     
  4. Simon Hampel

    Simon Hampel Co-founder Staff Member

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    IO loans require less cashflow since you are only paying the interest and not the principal as well.

    Naturally there is a cost here - over time you will pay far more interest with an IO loan than you will with P&I, since the loan balance never decreases with an IO loan like it does with P&I. Note that most IO loans are for a fixed period and convert to P&I loans after that expires ... although you can generally refinance them to another IO loan.

    With an IO loan you get to determine when you spend the capital to pay down the loan balance, rather than doing it on the bank's schedule. This gives you far more flexibility in managing your cashflow requirements.
     
  5. navjit6

    navjit6 Active Member

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    my brother has a PPOR with about 287k loan 5k in offset, and wants to sell within 2 years. It is currently P+I Loan, would it be better to refinance to IO loan. What would be the rough costs of refinancing?
     
  6. Simon Hampel

    Simon Hampel Co-founder Staff Member

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    Hard to tell. What is the interest rate and how much is he paying in monthly payments? I doubt the cashflow saved over 2 years would be worth the cost of refinance - unless the current lender is happy to make the change for free (or minimal cost).

    Depends on whether the same lender can refinance it for him (not so much a "refinance" as an adjustment to the existing loan facility) ... or whether he has to go to a new lender (in which case stamp duty and other costs will be payable).
     
  7. navjit6

    navjit6 Active Member

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    5.54% p.a
    pays fortnightly $805.00 x 26 = $20930 a year / 12 = $1744.17 a month
    yeh it wont make much difference i guess, unless can get same lender to do it cheap or free...i will get him to find out...thanks for your help sim!
     
  8. Simon Hampel

    Simon Hampel Co-founder Staff Member

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    $287K @ 5.54% interest = $15899.8 pa = $1324.98 pm

    This means that at the moment, he is paying nearly $420 a month in principal payments. By converting to IO (assuming you get to keep the same interest rate), this $420 per month is cash that can be used for other things.

    Just remember that you will end up paying more overall by paying IO - it's a saving now with a cost later. It is a waste if you aren't putting that money to good use, eg another IP or investing in shares/funds or even just putting it in the bank (or even better, an offset account).
     
  9. navjit6

    navjit6 Active Member

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    So are there any benefits from IO loan apart from cash flow (principal payments) you receive? I know it will be different for both PPOR and IP, could you please explain for benefits for both?

    As i see it, there is no other benefit except the extra cash flow for PPOR, and there is a cost later, which looks like it doesn't justify changing to IO loan for PPOR, as you must be making a massive return on that extra cash flow to make up for the future cost (from my rough calculations seems like you have to make at least 15% p.a.).

    For IP, you will have the extra cash flow plus will be able to claim more interest for the time that it is an IO loan (since your loan amount will be higher). But does this benefit make up for the future cost?

    IO loans seem to be popular among investors for IP's. Is the main reason, so that they have more cash now for investing in further properties/shares? I guess as example, if you have the cash flow now and use as deposit to buy IP now rather then 1 year later, you will also save money on the purchase price (assuming that prices continue to rise). if prices increased by 5% p.a. for $300k property, that would be a saving of $15k.

    I don't know if i am exactly on the right track, just want to gather more of an understanding of the IO loans compared to normal P+I loans, and which ones are better for PPOR and IP. Thanks!!
     
  10. Simon Hampel

    Simon Hampel Co-founder Staff Member

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    There's nothing wrong with a P&I loan if your goal is to just buy a property and pay down the loan.

    If you are planning on drawing down on equity for any purpose - there's no real point in paying down the loan, it just complicates things.

    You can achieve exactly the same net result as a P&I loan by using an IO loan with an attached 100% offset account. Which then gives you the opportunity to control when and how you pay down the principal on your loans, and gives you far more flexibility with your structure and planning.

    There is only one scenario where I think paying down the principal on your PPOR (as opposed to accumulating the money in an offset account) would be better - and that is if you plan on redrawing that money for investment purposes. If you pay the money into your PPOR, then set up a separate loan facility (ie split the loan account) to redraw that money out for investment purposes, the interest on that money becomes deductible.

    If you had accumulated the money in an offset account and then wanted to withdraw it for a deposit on an IP, all you've achieved is to increase the amount of non-deductible interest against your PPOR - which is not ideal ... paying down the loan and redrawing it (using a separate facility if possible) is much better.

    However, you don't necessarily need to use a P&I loan for that ... in fact it may actually make things more difficult, since the total amount you can redraw without applying to extend your loan is continually falling (the idea being that the loan balance should reach zero by the end of the loan term). You also want to make sure that the personal and investment loans are kept separate - especially if using P&I. If the personal and investment borrowings are from the same loan facility, the ATO may arbitrarily claim that principal payments you've made are against the IP rather than the personal component of the debt and thus decrease the interest you can claim as an expense - or there may be some confusion as to exactly which part of the loan is which.

    The only other caution I would add is that if you are likely to be tempted to withdraw cash from your offset account to use for doodads and holidays ... then you've not really acheived much (unless your offset account was only ever going to be for holding your holiday savings I guess). Offset accounts require discipline - so if you are not disciplined enough to use it correctly, then getting a traditional P&I loan is possibly more appropriate.

    At the end of the day, it comes down to your long term plans. Think about what you would like to do down the track - are you planning on buying more IPs? Would you be redrawing equity to fund other investments? If so, start your structure planning now - we see so many people come on here posting that they have found themselves in a situation where they've destroyed all of their tax benefits by not thinking ahead.

    If all you want is a house to live in that is paid off and you won't ever borrow against it - go ahead and use P&I (in fact, pay it off as soon as you can - you'll feel much better for it). If you want to invest and use the equity you've built up for leverage, use IO loans and offset accounts.

    Start with the end in mind.
     
  11. Simon Hampel

    Simon Hampel Co-founder Staff Member

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    One day I'll make up a flowchart which shows all the likely scenarios for buying property (both PPOR & IP) and explain which loan structures are more appropriate in which scenario. One day.
     
  12. navjit6

    navjit6 Active Member

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    i want to use for investment purposes, i would like to get at least 5 IP's in the future. So out of the following 2 scenarios you think the first one is better for PPOR:

    1. pay P+I loan on PPOR, and then draw equity when you have paid some of the loan of for deposit on an IP. Any savings would go to my offset account on PPOR.

    2. Use IO loan on PPOR, and use the extra cash flow, which i would first put in offset account to get deposit for IP.

    Which way
     
  13. navjit6

    navjit6 Active Member

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    that will be quiet a challenge. good luck
     
  14. vsdabhi

    vsdabhi Member

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    P&I for PPOR and IO for IP is a good idea. I did the same thing. We bought our PPOR in Feb 08 with 85K deposit (20%), After 11 months I bought my first IP, I use equity from PPOR to put 20% deposit. And we did not pay LMI. Same bank lent us for first IP. When we decide to buy 2nd IP after 6 months, we had not 80% equity including 2IP's and bank asked us to pay LMI for all 3 properties (above $18K). Some one from forum family member suggested to find a new lender. We borrowed $53K (equity from first IP and PPOR) and paid $5K LMI and bought 2nd IP. But for third IP we runout of equity. So we used off-set savings from PPOR as a deposit and bought 3rd one with again $5K LMI. In this scenario, interest only is very much useful. (There will be a tax saving loss because we use offset money as a deposit, Did we have another option?)
    Now the question is, how can we buy a 4th IP? Market is slowly moving in upward direction. We will have 5% deposit in offset within 4-5 months but will there any equity?
    Our plan is to have atleast 5 IPs before 31st Dec 2010.
    Thanks
     
  15. CJ. Wentworth

    CJ. Wentworth Well-Known Member

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    My apologies if Sim has already stated this, and I'll try not to ramble to avoid confusion.

    If you plan on converting your PPoR into an investment property into the future, you could consider holding it with I/O 100% offset.

    While it's your PPoR you can pay as much into the offset to save on interest. When you plan on converting it into an IP you can redraw the funds from the offset (for whatever reason) and then claim the full interest as a tax deduction.

    You could couple this with the 6 year rule which allows you to treat your PPoR as an IP so long as you don't own another PPoR. 6 years down the track you can sell your PPoR (converted to IP) and not have to pay CGT on the proceeds of the sale.


    I'm sure Sim has already stated this, but it all comes down to future planning. If you think that you want to be able to move your funds around, then IO with Offset make the whole process much easier when considering tax purposes.


    For obvious reasons, speak to a professional. Financial Planner, accountant, anyone who can actually verify any of my ramblings. I am NOT a qualified anything at the moment, just a finance aficionado
     
  16. KimandGlen

    KimandGlen New Member

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    Another main reason people use I/O loans is for the tax benifiet.

    The property might be your PPOR now, but if you decide to turn it into an IP one day down the track, you might find that you aren't able to claim the full interest amount on tax, especially if you redraw from that account to use to purchase another PPOR.

    All investment properties should be I/O anyway, you are better off repaying / increasing your offset account on personal debt.

    It is all about getting the structure correct from day one to give you the most options and freedom for what you would like to achieve in the long term.