Interest Only Loans VS P&I

I've read in a few threads on this forum that for investment properties, the optimal is an interest only loan - that is to get the most tax benefits.

I don't quite understand how this is good. I see the benefits that if paying interest only, you have more cash to use elsewhere. However, from a long term investment perspective, isn't this a bad thing to only just be paying interest. My thinking is:

1. Your principle is never reduced and your debt is always the same.
2. Wouldn't that affect your borrowing capacity because your loan isn't reduced, and your equity growth is always low (unless your property value booms).

 

If u have non-deductible debt then paying pi on an investment loan means you are diverting money from this to paying down investment debt which means Les tax deductions.

If no non-deductible debt and a paid off home then paying PI would be good.

 

You should be putting money into the offset instead, rather than simply not paying anything beyond the IO amount. Eg if your P&I are 3k/mo and IO is 2.2k/mo, you should really be paying the extra 800 into your offset (even more if you are able) so that you are essentially reducing the interest payments, and at the same time building a cash buffer for emergencies. If you lose your job or have a medical or other emergency, you have access to the cash, and when you take it out the tax on the extra interest you will pay to the loan is tax deductible.

But for your second point - yes it does reduce your borrowing capacity - but I believe it reduces it by the exact amount that you have in your offset that would have otherwise gone into paying it off, so there is no actual loss in how much you can spend on your next property since you can just use the cash instead of putting it into the property and then borrowing it out as equity.

Ideally though the property would increase in value so you can still take that out as equity and not touch your cash buffer (other than for an emergency that is, such as when you are forced onto P&I after 5 years and if the rent does not cover P&I yet).

 

That is a good thing. A borrowed $500k now is still $500k in 10 years time. But after inflation it is worth less than $500k. Assets appreciate but the debt depreciates (slowly).

Also, IO are really PI loans, but you get the choice of when and how to pay back the principle. By having IO you can pay no extra or reduce principle when you want to, and re-draw it later if needed. Can't do that so well with PI loans. All about having more control of your loan.

 

That's not the primary benefit.

The idea is that if you have a PPOR debt (ie. a non deductible debt) then the focus should be paying that off first - and then once that's done consider paying down the deductible (IP) debt.

Speak with a good accountant though.

Cheers

Jamie

 

Consider IO rates is going up will it still be a good idea to borrow from IO loan?

 

From my experience IO loans should be used with caution for newbies. My first properties were IO and those days rates were higher. I was making amazing money all of a sudden from my Internet business and I had never had money like that before. I was making 10k+ per month passive income.I could spend 2 hours a week or less and it would not matter, the money kept rolling in. So I purchased a few properties within a few months all IO, renovated and rented them out. Then I took of traveling around the world, lazing on tropical beaches and just doing a tiny bit of work on my laptop.

It was difficult to concentrate in the tropics with the heat and lots of other distractions. Then a few things changed with Google rising etc and my income started to head down on a downward spiral. I kept making reasonable money for a few more years but not as much as the peak times so I sold a property to allow me to continue my adventures abroad, the money from that lasted a couple of years of heavy spending.

I was also conned into getting a credit card by my mortgage broker with one of my property purchases as it came with the package they setup for me. Fast forward a few years later and my income was just a dribble and to stay at my tropical beach home I had to start using my cc and i was thinking my Internet business would pick up so I was not too worried, Unfortunately it didn't and I came back to Australia with a 10k cc debt and my finances were strained.

The point is you never know what can happen and like me if I had paid off more principle over that time when I had heaps of cash I would never have got in my situation and it might have made me stay back and save more.

If you have a really steady job and assets to backup in hard times then go for it but if you are not certain about your future then I suggest newbies pay some principle off as well. Sure, this might not be the best strategy but it gives you more backup in hard times.

Now days things are changing for me fortunately. My Internet business is picking up again. I sold a property recently above listing price and I'm planning to invest money in running a bricks & mortar business and buy a couple of properties for cash soon. I will then build my income record up again over the next few years and save and look at borrowing again. But for now it's great to be debt free and have a nice bank account with dreams I can choose the one I want to follow.

 

You want to pay back more money, so you can borrow more money?

Takes awhile to get your head around (or it did me). You either are trying to get more money or pay it back, not both.

Offset accounts are your friend along with discipline.

 

Is IO rates soon to be on the rise? Has it been announced?

 

Yes and Yes - APRA cracking down further.

 

Most lenders charge a premium for IO now and another premium when the loans purpose is defined as investment.

 

Cracking down on what?

Have they announce how soon and how much it is likely to rise?

 

Cracking down on what they think are loose lending practices. Each bank must decide what action to take and when but i except some Io rates to rise and it will be more difficult to get Io loans in general.

 

Have been thinking about this and wondering if a combination of IO and P&I will begin to work in the future?
Meaning straight IO with begin to get harder and the reason being is that APRA want to see debt being reduced.

But perhaps by splitting out your loan with a majority on IO with a secondary split on P&I then it may be a compromise.

Obviously this will just be for owner occ debt.

 

Thanks

How soon can we expect this and are what kind of increase. 0.2, 0.5 or over 1pc?

 

Who knows?

 

I really think you need to be on top of this as you can't hide your head in the sand and expect nothing will happen. The environment changed and changing fast, so don't expect to be spoon feed everything without doing any of the hard work.

 

There was an article in the SMH yesterday about IO loans too.

 

And not only that - it's already 2 years in of changes. I still do get the occassional investor come in who has been out of the market pre-APRA changes and are shocked at the new environment. Finance makes the world go around (especially the investment part) - so best to stay informed and open to those giving advice. What was a set in stone rule 2 years ago is not relevant today.