I/O for IP.....is this always the best strategy?

Hi All,

Curious to know if people feel I/O is 99% of the time the way to go with IP's?
If so, how long to people tend to stay on I/O?
Under what circumstance is it best to go P&I on an IP?
Just a general question looking for some insight.

Thank you

 

No it certainly isn't always the best strategy.

 

I've done the math of P&I vs IO. Iif you're investing for the long term, you're usually going to have better outcomes with P&I payments from day one.

 

Best is a bad way to ask the question.

 

Ok, how would you word the question then?

 

In what circumstances is IO preferable to PI (and vice verser) ?

 

Sure thing but I am not going to go and change it now just because some people think they have a better way of asking it. Didnt start the thread to have my question ridiculed, just looking for some advice.

 

Thanks for your input, really valuable

 

Interested to see some numbers/explanation on this, I get the property couch idea of "accumulating" and if you go P/I obviously cash flow is restricted.

 

Hi @Peter_Tersteeg, don't suppose you are willing to show at least a brief logic to why that is the case? I am very intruiged to see your logic as I am currently deciding if I should go to IO

 

It really comes down to individual risk appetite & strategy - there's no single right or wrong answer here.

If a client is risk adverse and want to accumulate slowly and pay down debt at same time, and only want to accumulate say, 2 or 3 properties as the end goal then P&I may be a good fit as they reduce existing debt level until comfortable before accumulating another one. And then rinse & repeat.

If a client is young, on decent income and want to grow portfolio aggresively then IO may be a strategy they can implement. Better cashflow control while keeping debt in IO, which means they can save up deposit quicker to buy again, and then look at improving the cashflow or reducing the debt level after initial acquisition phase is complete.

Note this is general advice only.

On an interesting note I've thrown this question to Chris Gray on our recent podcast episode. You can check out what his thoughts are here:
Ep27 - How Chris Gray built $15million property portfolio. And shares his secret to achieving work life harmony..

Cheers,
David

 

I know others think differently but I am a big fan of I/O loans, especially those with Offset accounts.

So much so, I don’t have any P&I loans - all are I/O, some fixed and some variable with Offset accounts (some of these are now fully chocked).

This is my thinking:-

One needs to know that typically I/O loans incur a slightly higher interest rate. In my case, the premium is 0.2%.

So, on a $500,000 loan, the ‘penalty’ for going I/O is $1,000 pa ($20 pw) in extra interest (assuming worst case scenario of no funds in the Offset) and the additional cost is tax-deductible.

People spend more than this on coffee and this cost is not tax deductible .

I particularly like the lower cashflow requirements of I/O.

One can always mimic a P&I loan and put the principal component in the Offset. Although not preferable, if need be, one can withdraw these funds and the increased interest is tax deductible, even if consumed on personal expenses.

One can’t do that with P&I loans. That is, withdraw the principal component.

My strategy is to not only put the principal component but to throw every last dollar earned into the Offset.

Probably a bit whacko but that’s my thinking.

 

I put together a spreadsheet modelling the outcomes years ago. I'm not going to claim it's absolutely correct, but I have had a few clients who are accountants look over the math and they haven't taken issue with it.

One accountant was quite adamant that IO was the way to go, until he went through this.

What it's basically saying is that you get a significant cash flow boost during the interest only period. After that, the loan will cost significantly more, to the point that you'll pay back that cash flow saving, plus quite a bit extra.


The best argument for IO is that you're saving that short term cash flow for another purpose. Paying off non-deductible debt, saving another deposit, there's plenty of good reasons. However if you're not doing something useful with that extra cash flow, you're really just wasting money.

What is definitely not a good reason for IO is because you can't afford P&I repayments. If you can't afford P&I at the start of the loan, you can't afford the loan.

People will argue that that you miss out on a lot of tax deductions by paying P&I. In this example you'd loose $533.35 per annum at the most at year 5. This figure reduces after that.


As a mortgage broker I know that with only a few exceptions, P&I will get you further in terms of borrowing capacity. One recent analysis suggested with P&I repayments, borrowing capacity is about 20% higher than with a 5 year IO term. If your loans are all 10 years IO, the serviceability outcome is going to be very grim.


I'm not suggesting that P&I is always the right way to go, there's plenty of good reasons to have an IO loan. However many people have an automatic assumption that IO is best for investment without really understanding the strategies behind it. If you don't have a strategy for an IO loan, then P&I is probably going to have a better outcome in the long run.

 

Thank you David for your post, great advice and insight! PS just subscribed to your podcast

 

I like this strategy, it makes sense!
Is your PPOR I/O also or do you rentvest? Thanks for your input

 

Thanks Peter, very interesting!

 

I like your method, i'm doing the same with IO on my PPOR, extra funds are being used to renovate thus creating equity and invest sooner in theory. The rate cuts and an income increase has helped greatly also.

 

Thanks Peter, very interesting
I do not at all question that purely looking at this single loan it is cheaper to go P&I however, the reason I was leaning towards IO is the increase in cash flow now meaning I can save up for the next deposit easier as you mentioned. One option that I don't think you have mentioned but I'm sure you have come across throughout your career is going IO for 3 years to save up your next deposit but then refinancing to a 30 year P&I loan once you have saved up the necessary deposit as to not effect future cash flow or servicing. I would very much like to hear your input on this scenario.

Thanks,
Nick

 

Our current PPOR is debt free although we have used it as security for a deposit on one IP, our next ideal PPOR. That loan is I/O and at PPOR rates .

In this way, when we sell our current PPOR, our next PPOR will become debt free.

 

Interest only loans are all about the strategy. Great examples about how they can work, but also make sure you know that eventually the lender will make you go to P&I repayments. Refinancing and resetting the loan term is a good way to deal with this, but make sure that ensuring this option is available (if that's your plan) is also part of the strategy.