Help me work it out - Better PI or IO?

As per post #35 above, simply looking at the current repayment amount (IO vs P&I) is insufficient. You need to look at the whole term of the loan (especially including when IO reverts to P&I) to see if the short-term IO savings outweigh the higher future repayments.

The target returns to make IO worthwhile are not unreasonable, but they are all higher than the PPOR rate, therefore simply using IO savings for PPOR P&I debt reduction sees you worse off than just going P&I for your investment loans from the start (calculated to consider deductions at various marginal tax rates.)

What we all used to consider the 'sensible approach' (IO on investments, extend extend extend) is no longer the default sure-win method now that banks are APRAhensive. The bottom line has changed.

 

Also with PI loans some banks will also periodically reduce the monthly repayment to the minimum as you slowly get ahead. This often happens with rate changes.

 

Perhaps, but nor is comparing the entirety of the loan periods a sufficient answer to "which of IO or P+I is better" . Because how many of us will simply sit on our hands and just revert at end of IO period, rather than refinance (into new P+I, IO or fixed etc etc)?

Assuming that you can refinance that is.

Any IO vs P+I comparison must be short term, as the ground is shifting so quickly. Let alone consideration of other variables such as tax, use of IO saved cashflow to generate additional income etc.

 

If you are ahead on your loan you can request your bank recalculate your minimum repayment. I don't know how often though. I don't think they would like it if you asked every month.

 

Being able to refinance and/or extend IO indefinitely is obviously ideal, and what we all want to do here. If one is confident that they can do that in the current environment, then IO is their best choice as the lower repayments free up funds for non-deductible debt and further investments.

However if you work on the assumption that the a property loan will eventually come to an end, you then have to check how effective that IO saved cashflow was in generating additional income.

Note that just because you go P&I, doesn't mean you can't equity release in the future. On the usual strategy of regularly topping up each IP to 80/88/90 LVR in a rising market, the only difference between IO and P&I is that you'll pay less interest with P&I. Purchasing power for subsequent investments remains the same.

 

I work with properties generating 7-10K CF+ though, so the efficiencies, and therefore the compounding benefits of those efficiencies, are accelerated/supercharged. This is why the strategies I use are exceptions (and exceptional) to the rules being compared where "vanilla" apple v apple, I/O v P&I scenario's are being calculated.

 

IO used as a tool to free up cash for high return investments like yours is a wise choice. The short term savings enable enough profitable investment to outweigh the higher loan costs if/when IO reverts to P&I down the track.

My reply was specifically referring to your mention of directing all available cash flow towards PPOR P&I debt reduction. That's the vanilla case where IO no longer makes sense.

 

I give it approx 2-3 years before the squeeze on finance causes a massive drop in investor activity and a lack of available rental properties and we see a swing back in the other direction.

Who knows.... we could see today tonight episodes of tenants bidding at rental auctions....

 

Those are my thoughts too - building starts are already dropping. Once the excess supply is soaked up and provided immigration doesn't slow, it will get interesting. Things can only get better from here - the slowest rental growth in 20 years (in Sydney presumably) was worth of a mention in this month's RBA statement, which is a pretty rare occurrence.

 

i think this may be over complexed here.
My thoughts are,
The general guidelines were, put the investment property loan on IO, and pay the difference between P&I and IO into your PPOR offset.
so if P&I was $1500 and IO was $1000 you pay your $1000 IO loan and the put $500 into your PPOR offset.

And no one ever had the intention of going IO for 3-5 years then reverting to P&I untill the end of the 30 year term.
For arguments sake we have to assume we would still do the same as in the past, whether we can refinance or not is a complete different subject. But we should assume we will refinance either IO again or P&I over a new 30 year deal, it dosent matter for the calculations, lets just look at the current loan for now.

I think its best to look at a 5 year loan as thats fairly typical, and 10 is very lender dependent.

I think what needs to be worked out here is

-1 The diffrence between paying IO and P&I on your investment loan.
-2 The loss in tax claims you can make by paying this off the investment loan
-3 The loss in cash flow from not having this extra in your PPOR offset.

This is easy for the first month

say for example a 300k Investment loan at 5% on IO or 4% on P&I

1 payments are P&I = $1433 and IO = $1250 so diffrence is $183 per month
2 37% (tax rate assumed) of 183 = $67.71
2 so say PPOR is 400k @ 4%. IO payment is $1334 per month. normaly we would add the $183 to the offset reducing it to a $399,817 loan with a $1333 payment, so only loosing $1.

so in the 1st week we would be 67.71 +1 $68.71 PM worse off in cash flow if we went P&I

but i have not got the skills to calculate this for the whole 5 year period.

if the rates were raised on our investment loan for IO to 5.5% i get about $22 worse off cash flow for P&I

At if IO loan is 5.7 % and P&I is still on 4% P&I gives better cashflow.

so at these rates the IO loan needs to be 1.7 above the P&I before it makes sense to change to P&I , (for the 1st month) i assume if it can be calculated over 3-5 years it will make sense to switch at lower rates.

I am by no means confident this is correct as you guys are way ahead of me in this game, its just how i see it in my mind.

Any thoughts?

Are my calculations absolute crap ?


Of course if people are using the extra cash flow to pay a neg geared property or for a reno or whatever else, then its a different subject again.

 

and perhaps
4. The extra return you could get by recycling debt and investing that money

 

this was my take on it;
Is Principle and Interest (P&I) or Interest Only (IO) better on my investment loan? - Travis' Blog

Lets assume your Owner Occupied rate is 4%, IO investment is 5% and P&I investment is 4.8% (0.2% discount). Loan amount is $500,000, payment over 30 years.

To work out the principle payments each month the Excel formula PMT can be used.

=PMT(4.8%/12, 30*12, 500000)

Which results in monthly payments of $2,623 or yearly payments of $31,480. This is the amount that won’t be able to offset the Owner Occupied at 4%, this is equal to $1,259 a year.

If the P&I and IO rates were the same, we wouldn’t want this loss and stick to the IO, but it isn’t the case. at 4.8% interest first year is $16,800, whilst IO at 5% is $17,500, a difference of $700.

In this case, P&I costs $559 more a year, and it would be better to go IO, even at a slightly higher rate. Simply, right? Well, not quite.

As investment loans are tax deductible, comparing the interest only isn’t a fair comparison. In a situation where P&I is more cost effective then IO initially, it is worth then calculate the interest payable after factoring the tax deduction. It may make the IO more favourable. But if it does, the savings differences may be negligible compared to other factors.

 

Just contemplating on this today.
If there I have the cashflow and hasno better use of the money, the higher repayment of the PI might worth it depending on % difference on the rate

e.g. if I can get the best rate for the smaller loan for the first one, the higher repayment is worth it (there's no where else I can pay $260 and get $1500 worth of value).

For the 2 loans below, it will still worth it but need to consider overall cashflow and buffering.