Best option for fixing loan

Discussion in 'Loans & Mortgage Brokers' started by almostthere, 7th Apr, 2021.

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Best option to fix my current ppor( likely IP in 3 months)

  1. 2 year fixed @1.89%

    0 vote(s)
    0.0%
  2. 3 year fixed @1.98%

    2 vote(s)
    40.0%
  3. 4 year fixed @1.98%

    3 vote(s)
    60.0%
  4. Keep variable @2.65%

    0 vote(s)
    0.0%
  1. almostthere

    almostthere Well-Known Member

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    Looking for some suggestions here.
    This is our ppor currently but will most likely be a IP in about 3-6 months time as we are actively looking to upgrade our ppor.

    We won’t be selling current unit for at least next 4-5 years for sure.
     
  2. Tony Xia

    Tony Xia Structured Loan Advisor Business Member

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    Are you buying a new PPOR?
     
  3. almostthere

    almostthere Well-Known Member

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    Yes
     
  4. Tony Xia

    Tony Xia Structured Loan Advisor Business Member

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    Then these aren't the best options. You would want to restructure these loans to interest only INV and refocus the extra cash into your new owner occupied property.
     
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  5. almostthere

    almostthere Well-Known Member

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    I agree but the IO rates (INV) is quite high compared to P+I (PPOR)

    2 year IO 2.49%
    3 year IO 2.59%
    4 year IO 3.09%

    with IO rate being that high , I think I am better of paying of P+I even if it will be investment loan in future

    This is with NAB between. Is there any other better IO fixed rate for IP?
     
    Last edited: 7th Apr, 2021
  6. MC1

    MC1 Well-Known Member

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    You need good advice as you clearly don't understand how this all works
     
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  7. PC_USER_456

    PC_USER_456 Member

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    I don't think it is as simple as you think MC1 but I'm happy to start a conversation about it here with interested parties!

    Interest only investment loans are 'good' because they let you maximise deductible debt and prioritise paying down non-deductible debt instead. However, taking advantage of this is not a costless exercise. Interest is an expense you still have to pay and you will only get ~50% off this back via tax deductions.

    It's easiest to explain this argument with a hypothetical 'silly' situation. If your PPOR non-deductible P&I loans were at 2% and your IP deductible I/O loans were at 200%, you would want to prioritise removing the I/O loans as quickly as possible.

    If you can accept this argument, it stands to reason that at more reasonable interest rate differentials (between P&I and I/O), for each individual investor there will be a 'tipping point'. Once the differential is high enough, there will be a point for each individual at which I/O no longer makes sense. The future tax benefits they expect to make may not offset the present interest expense when time value of money (not to mention the expected holding window of the asset) are taken into account.

    Whether most individuals are capable of doing the financial analysis (or correctly predicting the assumptions that would need to go into it) is a different question.

    My 2c.
     
  8. Lindsay_W

    Lindsay_W Well-Known Member

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    Yes hypothetically but the spread aint that big now is it? So the OP should get some credit and tax advice about which structure would work best for them and their individual circumstance.
     
  9. PC_USER_456

    PC_USER_456 Member

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    Sure. But depending on the size of your loan, the tax advice may cost more than getting it wrong either way. I subscribe to sticking your finger in the air. ;)
     
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  10. Peter_Tersteeg

    Peter_Tersteeg Mortgage Broker Business Member

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    The simple statement that interest only is better because it's for investment is actually pretty bad advice. There certainly are may circumstances where interest only is the definitely the better solution, but it does need to be taylored to the individual circumstances. In most cases the equation is one of short term cash flow vs long term cost.

    Even with a small difference in interest rates, IO still costs more. The tax deductions only compensate for a small portion of the difference and it's a diminishing return over time.

    IO works well when cash flow over the next few years is a priority and the extra cash flow is used wisely. Even better if there's an exit strategy from IO involved.
     
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  11. Lindsay_W

    Lindsay_W Well-Known Member

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    Such as paying down non-deductible PPOR debt?
     
  12. PC_USER_456

    PC_USER_456 Member

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    In my view, that would not be a great use of the funds in 'most' situations.

    Here are some hypotheticals where it does make sense...
    1. You're struggling to pay bills in the short term and you'd rather pay more interest in order to defer the principal portions of repayments. In particular, these bills either affect your ability to live or are accruing interest at rates like 20% (common for credit cards).
    2. You use the funds to invest in shares and expect to get a good return (which would need to be above both the I/O rate and, depending on your investment horizon and home ownership horizon for this specific PPOR, the return you otherwise expect on your PPOR).

    But in all situations the answer is "it's complicated". Arguments could be made in both of the above situations that selling a property might be the better choice. It depends on circumstances, leverage, etc.
     
  13. Peter_Tersteeg

    Peter_Tersteeg Mortgage Broker Business Member

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    It can be. But the OP hasn't indicated that they'll actually be borrowing for the next purchase.

    You also need to give consideration to the circumstances of what occurs after the IO period ends. I've seen a lot of people make all their IPs IO, then 5-10 years later get into real trouble when the loans revert to P&I and the repayments go up by 40%.

    I've seen successful investors build large portfolios using IO loans, constantly refinancing over the years releasing equity, then reach retirement age with loans rolling into P&I and no option other than selling most of the portfolio to only acheive a modest outcome becuase they didn't have an exit strategy.

    I don't have a problem with interest only loans, I just dislike the one size fits all approach that many investors (and brokers) take to interest only loans.

    Incidentally in the absense of any other information, in the original survey I think option of 4 years at 1.98% easily offers the best value. However there needs to be a little more consideration given to the actual circumstances and plans before making this decision.
     
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  14. PC_USER_456

    PC_USER_456 Member

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    The bottom line is, all other things being equal, I/O puts cash in your hand today at the expense of bigger liabilities to be paid down the road. The question for each individual is, what are you doing with this cash in your hand today? Either:
    (1) You need a plan to generate revenue from it that offsets the expense of your future liabilities; or
    (2) The utility to your life of having the cash today needs to outweigh the financial impost on you later. It's up to an individual how they measure a non-financial utility...
     
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  15. Lindsay_W

    Lindsay_W Well-Known Member

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    To me, it's simply a redirection of funds
    ie. redirecting the principal payments from the investment debt to the PPOR debt, reducing the PPOR debt faster and therefore reducing the total interest paid on the PPOR debt as well. Would it not make sense to pay down the debt that gives no tax-deduction/benefit at all as the priority?
    Once that is paid off then revert back to paying off the investment debt (depending on individual circumstances and end goals/future investment goals etc.)
    This can be taken further, recycling the debt back into other investments, such as shares

    I agree there is no 'one size fits all' approach but I don't agree with you when you say using the additional cash flow to pay down non-deductible debt isn't a good use of those additional funds
     
    Last edited: 8th Apr, 2021
  16. Lindsay_W

    Lindsay_W Well-Known Member

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    How likely do you think it is that they're going to buy it with cash instead of borrowing? Would be nice to be in that position :)
     
  17. almostthere

    almostthere Well-Known Member

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    Thanks everyone for the inputs. It's all appreciated.

    To analyze this bit more for my situation , I tried doing some maths with the following calculator
    Interest only or principal and interest: which one is right for you?

    upload_2021-4-8_13-28-28.png

    So for my scenario , for 3 year period with IO rate being 2.59% and P+I 1.98% the result was :
    • P&I cashflow is $11,000.64 p.a worse off than IO.
    • IO interest expense is $3,660.00 p.a worse off than P&I.
    • Higher tax refund of $1,427.40 p.a on interest only.
    • After tax, P&I expense is $2,232.60 p.a better off than paying IO.
    • After tax, P&I cashflow is $12,428.04 p.a worse off than paying IO.
    So, with the above, to be able to match the P&I expense benefit ($2232.60) .. I will have to make this much money from the additional cashflow of $12,428.04 if I were to go for Intereset Only.... This is about 17.96% return ..

    No way I can reliabliy make that much return. ..

    I guess I will better stick with P+I for now ..If the intereset difference margin was less, it would have been a different story I guess
     
  18. Paul@PAS

    Paul@PAS Tax, Accounting + SMSF + All things Property Tax Business Plus Member

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    I am always cautious about robo calculators. Whilst that assists a base comprision who knows what happens in a year, ten or twenty. What the calculator doesnt show is what equity is built through making minimum repayments eg P&I cashflow is worse off but actually builds equity, which also compounds. Longer term that could even be redrawn in part. Equity + growth are wealth.

    IO is only short term. Often a lender pushes the borrower to a cliff and future periods will be a shorter loan term eg 3 years IO means 27 years P&I. So repayments ramp up v's paying 30 years P&I. I have seen people refinance IO a few times and then it stops and the lender sets a term of say 24 years and this really raises the repayments. And if the borrower cant refinance due to circumstance its a tough position. eg kids come along.

    The higher tax refund is only because of a higher interest rate is being paid.

    The major issue with P&I v IO is the rate variance of 0.59% Could that spread even widen ? Policy could discourage lenders offering IO and they may widen that differential rather than it contract
     
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  19. PC_USER_456

    PC_USER_456 Member

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    Yeah to be honest that analysis is a bit rudimentary almostthere.

    Here are some questions for you...

    Do you have any plans to invest in more shares and/or a belief they will return strongly? If yes, I/O might be a good idea.

    Do you need cash flow in the near term to pay living expenses or because you immensely value living like a king for the next few years (and are happy to pay the extra debt back later)? If yes, I/O might be a good idea.

    Do you have any intention of selling the investment property in the near future? (Because this will mean less years for you to take advantage of tax deductions on a higher notional). If yes, P&I might be a good idea.

    Stick a finger in the air otherwise. At $600,000 loan size, I'm not sure that paying for tax advice will be worthwhile on this decision.
     
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  20. MC1

    MC1 Well-Known Member

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    Spot on Lindsay.
    With the spread between P&I and IO, I'd be putting all principal against owner occ and let IO ride
     
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