IO or P+I

Discussion in 'Loans & Mortgage Brokers' started by beith, 13th May, 2017.

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  1. beith

    beith Active Member

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    Hey guys, new to this forum and investing in general.

    I know generally speaking with IP the consensus had been IO in order to preserve as much cash flow as possible and therefore acquire a second deposit faster. However with recent interest rate rises and new bank levy, my current lender is currently offering me P+I which is about 50 basis points under IO which (correct me if I'm wrong here) is fairly significant.

    My question is, should I pay a lower interest rate but also pay some principal or pay the higher interest rate and have better cash flow now?

    Either way I can afford it and even if I were to pay P+I it wouldn't really affect my lifestyle (although I will be having to pay an extra ~20k/year). Is there any advantage to doing P+I now in the context of these new rate rises? Also if I do P+I, will I be able to access the additional equity in the property via refinance?

    Any help or advice would be greatly appreciated!!
     
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  2. Peter_Tersteeg

    Peter_Tersteeg Mortgage Broker Business Member

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    Advantages of P&I:
    * Lower interest rates and the gap is expected to widen in the future.
    * You pay off the property and own it outright eventually.
    * With most lenders, your serviceability is actually better.
    * Lenders will see you as a lower risk, better odds of an approval.
    * Over the long term, the loan will cost significantly less.
    * No chance of 'repayment shock' when the I/O period ends. After a long I/O period, repayments can increase by as much as 150% (depending on how long the I/O period was). In many cases there's nothing that people can do to mitigate this.

    Advantages of I/O:
    * Better cash flow (only during the I/O period). The surplus cash-flow can be diverted to paying down non-deductible debt.
    * Marginally better tax deductions during the I/O period.

    Personally I like to go with I/O for the first 5 years, then let it revert to P&I. At this point most of my loans are P&I. I'm also a little torn about the best approach for future IP purchases, in the current lending environment I think there's some very powerful advantages of simply taking the P&I route, even though this goes against the traditional thinking.
     
  3. Rolf Latham

    Rolf Latham Inciteful (sic) Staff Member Business Plus Member

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    xcellent write up bear !

    ta
    rolf
     
  4. Bender12

    Bender12 Well-Known Member

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    Hmm that's interesting I hadn't considered this at all. If you had 15 years of interest only then when that expires you have to make p & I repayments based on the 15 years loan term left. If you can't refinance and cant make the higher repayments then you will be forced to sell.
     
  5. Paul@PAS

    Paul@PAS Tax, Accounting + SMSF + All things Property Tax Business Plus Member

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    I always revert to the wog principle. If its P&I then you are always repaying principle but its does add to cashflows. But each $1 of principle - $1 of equity. That person repays $1 of debt and owns $1 more.

    If someone is older that equity may be important.

    Dont assume all debt is good based on tax.

    Bender observes a good cashflow problem.A taxpeyer of a 30 year mortgage with a 1 year repayment holiday has little issue. But imagine if aowner goes interest only for 15 years and the lender insists on debt reduction. Their capital reductins can be insane.Or their debt is maintained. Their equity wont change will it ?

    Property ownership always reverts to equity
     
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  6. Paul@PAS

    Paul@PAS Tax, Accounting + SMSF + All things Property Tax Business Plus Member

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    That couldbe the future ?
     
  7. Ideacrash

    Ideacrash Well-Known Member

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    Have to make a decision:

    Background:
    Planning to buy a home and land package. Two contracts ( land and build ). At this stage the property will be PPOR. No clear vision to convert it to investment later. Just trying to keep the options open.

    Option 1:
    3.99 P&I variable for both land and construction with offset

    Option 2:
    4.34 IO variable for both land and construction with offset

    Option 3:
    Land 3.69 P&I fixed for 2 years
    Build 4.43 IO variable

    Which one would you pick ?
     
  8. Terry_w

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

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    It depends
     
  9. beith

    beith Active Member

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    Thanks for such a comprehensive response.

    At the moment I'm leaning towards P&I since 50 basis points is quite significant and it 'saves' me about $4k in interest per year, which I feel will add up over the long term. I know IO has the advantage of keeping better cashflow, but if I'm eventually looking to refinance and take equity of the property to invest in future properties then I suppose its much the same as IO? of course IO does offer greater flexibility - money is available anytime whereas P&I is only available through refinance. Am I correct in thinking this?
     
  10. Rolf Latham

    Rolf Latham Inciteful (sic) Staff Member Business Plus Member

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    What are your goals and resources ?

    No clear vision to not do x................. isnt helpful which is maybe why you are in a quandry ?

    ta

    rolf
     
  11. Ideacrash

    Ideacrash Well-Known Member

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    this would be my first property and thinking for building a portfolio overtime which can generate atleast 3-4K per month of income ( I understand this is a long term goal ) . Still thinking should I go only real estate or 1 PPOR rest in shares or split the investment between real estate and shares. Still in my 30's so can work for some more time.
     
  12. Rolf Latham

    Rolf Latham Inciteful (sic) Staff Member Business Plus Member

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    Cool

    so the primary benefit of going PI over IO in your case would be ?

    ta
    rolf
     
  13. Jess Peletier

    Jess Peletier Mortgage Broker & Finance Strategy, Aus Wide! Business Member

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    If you don't have a PPOR, definitely go IO - you'll want as much cash as possible to use as a deposit for that purchase or you'll find yourself borrowing the majority of it as equity out of your IP. Ideally, you want your IP loan to be higher and your PPOR loan to be as small as possible.
     
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  14. tobe

    tobe Well-Known Member

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    P&I. It's interest only until the constructions completed in any case. IO with offset is only a recomendation if you think the ppor might turn into an investment at some later point.
     
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  15. Ideacrash

    Ideacrash Well-Known Member

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    Less debt and less interest lost in the long term
     
  16. tobe

    tobe Well-Known Member

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    Make sure your lender has both contracts for valuation and approval well before the land settles. Even though there are two different vendors the bank does it as one loan. You get the fhog and stamp duty discount, and don't have any risk of short vals if you do it as two loan submissions. Doing just the land means you pay a higher rate of stamp duty, two mortgage applications and the builder won't start until the second application is approved and docs signed.
     
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  17. Ideacrash

    Ideacrash Well-Known Member

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    Isn't it less stamp duty if I am just doing the just the land first. I hav submitted all the docs to lender they hav verbally confirmed it should be alright . He is doing separate as I don't have the final build contract yet. I believe I can apply for fhbg only after I sign the construction loan ?
     
  18. Rolf Latham

    Rolf Latham Inciteful (sic) Staff Member Business Plus Member

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    The less debt is a management thing of PI Vs IO with offset, but only if one can justfy the higher rate. If one is looking just at rate, then refinancing to an online only lender with PI after the build can be a good strategy.

    If you pay income tax at above the 20c in the dollar bracket, I would consider looking at having an active debt recycling strategy modelled. While this needs mainly an IO facility, the middle term outcomes can be far ahead of a saving on PI vs IO spread

    ta
    rolf
     
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  19. tobe

    tobe Well-Known Member

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    It's better doing them together. Settling the land first runs the risk when the build contracts ready the valuer may short value your land. It happens a fair bit especially in new estates. It's also a risk your details might change, or the banks policy, or the wider market might change between settling the land and getting the build loan.

    You only get fhb or ppor stamp duty discount if you have a build contract and the fhog approved. Doing it separately means you have to pay the full amount and then apply for a refund, if anyone tells you. Most bank staff won't. Many don't do much house and land loans.

    Stamp duty is only charged on the land value regardless of whether you have a build contract, build loan approved etc. the only reason stamp duty would be higher is if the house was actually built on the land when you sign the land contract (the value of the property at contract date).

    I'm sure everything will be fine in your case, I'm just a bit of an idiot savant with construction loans.

    You'll find over the coming months getting a building contract can take some time, and then the builder can take their time actually starting work, while you are paying the land loan mortgage and mowing the grass, removing rubbish etc off the block.
     
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  20. Ideacrash

    Ideacrash Well-Known Member

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    Thanks tobe