IO Offset accounts and Minimum Amount Payable

Hi guys,
Quick question in regards to Interest Only offset accounts.
Is it true that when the Interest Only period ends a borrower will have to pay full P&I regardless of the balances in their OffSet accounts ? I think it's called Minimum Amount Payable hence the title.

Meaning that even if ‘no interest/partial interest’ has been charged in the first 5 years (depending on how money money the offset account has), it will now be charged by the bank and used to reduce the term of the loan disregarding the value in the offset account.

Cheers

 

@paulF

The principal repayments will be calculated over the remaining loan term.

If you have funds in the offset account, it will not reduce the payment to be made. Funds in offset will mean that more of the payment will go toward reducing the principal.

 

You do not pay 'extra' interest after the 5 years - it just means you have 25 years to pay off the rest of the loan instead of 30, so during this time you would pay principal at a slightly higher rate to make sure the loan is paid off in the shorter term.

 

Yes unless you "do something" to put the loan back on interest only terms (such as refinance, or request reversion to interest only with your existing bank), you'll roll onto "principal and interest". The more you have in the offset account, the less "interest" you can be charged but as has already been pointed out, there will still be a set minimum amount you are required to pay each m month. It's just that the interest component of the payment will be less if you have offset account funds helping ward off interest, and therefore the principal component would be larger and you'd see your loan balance go down faster.

 

yes

 

Thanks very much for the replies guys.
I understand how IO works and how the principal payments will go up naturally since the period of time to pay off the debt is less but my confusion is in regards to the relationship between the funds in the offset and interest payments part after the mortgage rolls into P&I.

Say i borrowed 500k on IO for 5 years with a 100% offset facility at 4% IR and a 30 year term:
Without any money in the offset, the repayments would be as per below:
Monthly repayments (5 years IO): $1,667
Monthly repayments (25 years P&I): $2,639

Assuming that during the five year IO period i managed to rack up 250K in the offset facility(obviously above 5 years repayment would be less due to money racking up in offset but please ignore for now) So after five years, the accounts rolls into P&I.

My understanding is that the 250k saved would still be offsetting the 500k so the 25 years payment above would less then $2,639 due to paying Interest on 250K only.
PS: tried to separate the principal and the interest parts to make my point clearer but my brain wasn't complying at this time of the night...

Is that reasoning correct please?

 

Having $250k in the offset will not reduce the minimum repayment required.

If minimum repayment is $2,639, and you have nothing in the offset, then interest will be calculated on the entire $500k loan and the balance will be principal repayment.

At 4% rate, at the 25 year mark, minimum repayment will be $2,639 (including $1,666 of interest and balance of $973 will be principal)

If you have $250k in the offset, interest will be calculated on $500k minus $250k ie remaining $250k @ 4% = $10,000 pa in interest / $833 in interest and remaining $1,806 will go toward reducing the principal

Hope this is clearer?

 

Imagine you had $500,000 in the offset. If your logic applied there would be no repayments at all, but this is not the case.

The loan would be fully offset so no interest would be payable, but the minimum repayments of $2639 would be charged so each repayment would reduce the principal by this amount.

 

Thanks very much for that @Property Twins, @Terry_w and everyone else.
Much clearer now.

 

Maybe it’s easier to think of the loan term reducing when you have p&i payments and money in the offset.

So while the term starts out at 25yrs, if there’s half the principle in the offset account, less interest being charged, and therefore a greater proportion of the repayment amount being directed to reducing the principle the term also reduces.

So after one year of ‘normal’ repayments the remaining term is now only 15 years (as an example).

The good news is if you redraw those extra repayments and/or spend the offset funds as you go you can lengthen the term back out to 25 years.

A good problem to have in the current environment.

 

In this thread below I worked out that if a PI loan was fully offset it would pay itself off in about 15 years without any extra repayments:
Loan Tip: If a PI loan was fully offset how soon would it be repaid? Loan Tip: If a PI loan was fully offset how soon would it be repaid?

If it is half offset then it might take around 22 years.

 

If the original IO loan was for investment purposes (most likely the case) and it becomes P&I, I would recommend taking funds out of the offset if they are for personal purposes.

I believe that redrawing the extra repayments out of the loan for personal purposes would “pollute” the loan .

That is my understanding but I am happy to be corrected.

 

Great and simple way of looking at it @tobe, thanks for that. Really simple when you look at it with a clear mind.
@kierank , PPOR that will be turned into an IP most probably after IO reverts to P&I but yes, that was the plan in the first place. Get as much money as possible in the Offset and take them out when I move out and turn the place into a rental.

 

You can always keep requesting the bank to reduce the minimum payments too as the offset account will mean you will be paying off extra.

 

... and we are planning to do the opposite. That is, later this year, turn our most expensive property purchase (currently an IP, bought 2 years ago) into our PPOR.

Yep, that was our plan prior to buying it.

Isn’t this property “game” a great place to participate in; so many different strategies, options, ...

 

Thanks again @Terry_w and as per @kierank , it is great to know about all the different options and strategies that we have under our disposal.

Extremely grateful and thankful for the PC community that jumps to clear up any confusion