IO or P&I on investment

Discussion in 'Investment Strategy' started by Philby, 6th Apr, 2019.

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  1. Philby

    Philby New Member

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    Hi

    Can anyone advise on a new IP and type of loan I should have to maximise tax benefits?

    I've recently converted my existing home to an IP (my first) and used equity from this property to purchase a PPOR. Financial Planner (from bank) has advised me to have the newly converted IP loan ($475k) as a P&I loan @ 3.79% and have an offset account of $20K against PPOR loan ($640k).

    So Im not sure if this is the best utilisation of negative gearing tax benefits? Would I be better to have the IP loan as an IO loan @ 4.3%? Would it be better to have the offset account against IP or PPOR?

    Appreciate any advice.

    Cheers
     
  2. Rolf Latham

    Rolf Latham Inciteful (sic) Staff Member Business Plus Member

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    Needs a bit more data really. If the 20 k in the offset is savings it should be against the owner occ loan.

    Suggest u get specific tax and credit advice

    I doubt that that pi loan at 379 is an invest loan. Sounds more like a ppor loan ?



    Ta

    Rolf
     
  3. Philby

    Philby New Member

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    Thanks Rolf, Bank has allowed the 3.79% rate (which is ppor rate) against IP until such a point when their policy changes as the property has been ppor to date.

    Will seek out some tax advice.

    Cheers
     
  4. AlbertWT

    AlbertWT Well-Known Member

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    If it is Interest Only loan, so how the actual loan is going to be paid off?
    Assuming no principal is paid for the first 10 years, the interest paid will always be the same :rolleyes:.
     
  5. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

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    You will pay PI after the IO period ends. You could also make extra repayments if or when you choose.
     
  6. Peter_Tersteeg

    Peter_Tersteeg Mortgage Broker Business Member

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    I've done analysis of actual figures of interest only vs principal & interest repayments.

    The amount of tax deductions you miss out on with P&I payments in the first 5 years is negligible. The cost of that decision affects your repayments for the subsequent 25 years.

    If this is a short term (less than 10 years) acquisition and short term cash flow is very important to you, then interest only might be useful.

    If you're thinking long term ownership of this property, principal & interest repayments are going to be a lot more cost effective.

    I've also run this analysis past some accountants who were convinced interest only is the way to go. When the worked through the modelling, they changed their mind.
     
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  7. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

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    I believe there is a way to pay IO on a PI loan and have outlined this in another place. Will be submitting a private ruling application soon
     
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  8. mat123

    mat123 Member

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    I'd be interested to see how you came to this conclusion. Over 30yrs you'd clearly save interest but lose the deductibility and incur opportunity cost on the money stuck in the property. Doing some (very) quick numbers, I can't see how you'd come out ahead
     
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  9. mat123

    mat123 Member

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    *Caveat: I used the same interest rate for P/I and I/O. It could obviously make all the difference if you can't get this
     
  10. Peter_Tersteeg

    Peter_Tersteeg Mortgage Broker Business Member

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    I've used actual variable interest rates for P&I and IO. Admittedly I haven't used some of the fixed rates currently available.

    The actual deductibility lost in the first 5 years by using P&I repayments is negligible.
     
  11. Rolf Latham

    Rolf Latham Inciteful (sic) Staff Member Business Plus Member

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    For those using an active debt recycle strategy, the P component, stuck into their home loan instead of investment debt makes a pretty decent dent in future outcomes due to the reverse compounding of that savings benefit.

    if someone has ONLY non ded debt, then obviously its a diff outcome

    ta

    rolf
     
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  12. Harry30

    Harry30 Well-Known Member

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    If someone had only deductible debt, makes no difference as I see it (apart from small difference in interest rate achievable with P&I v IO), assuming the borrowing is not cash constrained and is readily able to pay P&I. The amount of ‘I’ is exactly the same under the both scenarios. The additional ‘P’ you pay under P&I is just a ‘chop out’, all you are doing is reducing a liability. What am I missing?
     
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  13. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

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    True but...

    Different ownership structures will have different outcomes.
     
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  14. Peter_Tersteeg

    Peter_Tersteeg Mortgage Broker Business Member

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    I'm not going to claim that my workings are technically correct, there could well be mistakes. This analysis is fairly simplistic because it only assumes you'd make the minimum repayments ever, there's no offset account, your tax rate remains the same, you'd never refinance, etc.

    The tax deductions you miss out on by not paying off the principal for 3 years is $340.94 (per annum).

    Even with a cheaper IO rate than the current P&I rate, the IO loan is going to cost you more over the full life of the loan.

    At the end of the day, not paying off the principal in the first few years, costs you more over the remaining term. If nothing else, this tells us that paying off more, early, is a good thing.
     

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  15. Anne11

    Anne11 Well-Known Member

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    Agree with Peter’s calculation.
    I have done the modelling on my own loans and decided to use P&I, but only after resetting the loan term to 30 years, which means the repayment on the P&I is not much higher than the IO. The difference in interest of .5% over the loan amounts is much higher than the loss of deductibility. I will reassess after 5 or so years and also intend to slowly pay down investment loans as I won’t have non-deductible debts in 2 years. For someone who still has a large non-deductible debt and have tight cashflow, maybe better off to stick with IO loans, although it will cost more with this option.
     
  16. kierank

    kierank Well-Known Member

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    My preference is what I call a “hybrid” P&I loan.

    By this I mean, an I/O loan with an Offset, where one pays the “I” on the loan and one deposits the “P” into the Offset.

    Great for IPs as one can use the Offset as one’s cash reserve and the interest charged on any withdrawal (personal or investment) will be deductible.

    Great for one’s PPOR if one later converts it to an IP as one can, at that time, withdraw funds out of the Offset (for whatever reason) and the interest paid on the loan including the withdrawal will be deductible.

    Not advice.
     
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  17. FrivolousPanda

    FrivolousPanda Well-Known Member

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    The downside is you don't get the lower interest rate for a p&i loan but do get the flexibility you mentioned
     
  18. Luca

    Luca Well-Known Member

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    Yes but if you park your money in the offset you pay less interests on the P&I
     
  19. Peter_Tersteeg

    Peter_Tersteeg Mortgage Broker Business Member

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    Not quite. The cash flow loss of a P&I loan is higher because you've got minimum repayments that don't reduce with money in the offset account.

    However the interest you're actually charged is less in a P&I loan for two reasons:
    1. The amount you are being charged interest on reduces with each repayment.
    2. The interest rate is lower.
     
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  20. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

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    Correct. But the repayments are the same if pi