Loan structure for first property

Hi,

Seeking some advice on whats the ideal way to set this up.

Recently bought a first property at 1m mark. Initially wanted to move in, but have now decided to rent it out first. May move in after 2 years, but not ruling out continuing to have it as an IP (or even sell it).

I've got about 600k in cash for this property (Will not put them in shares as I've already got this asset class covered). No debts. Our household income is 110k + 140k, salaried. We are reasonably disciplined in our savings.

What would an ideal setup be?

1) I was originally thinking
- 300k, P&I fixed interest for 3 years, no offset and
- 500k P&I Var interest with 100% offset.
I would leave my remaining cash after the 20% deposit in the offset.

2) Then, I toyed with the idea of
- 300k, P&I Var interest with 100% offset and
- 500k, IO Var interest (IO rate is about 0;.66% higher than P&I) with 100% offset.
I would leave everything I have left after 20% in the IO loan's offset. Essentially, the aim is to not pay any interests at all. So this loan would be "0".


Which is a smarter options and why?

Should there be anything else I consider?


Thanks!

 

The way I'm reading this (and it's not entirely clear), you only need to borrow $300k in total, but you'd like to borrow $800k (80% of the purchase price).

That then assumes you'd have $500k cash left. You should probably leave at least this much as variable so you can fully offset it.

You've also indicated you'd like to fix part of the loan for 3 years. How much would you expect to save over 3 years? You probably also want to have this amount as variable. So if you can save $40k per annum, you'd have an additional $120k as variable so you can put your future savings into an offset account as well.

That way the loan structure might look like:

$500k variable with offset
$120k variable with offset
$180k fixed for 3 years

-or-

$620k variable with offset
$180k fixed for 3 years

Something else to consider is you've mentioned an interest only option. Realistically it's going to be very difficult to get a $500k or more interest only loan against your own home. The regulators don't like it and the lenders are all taking their queues from that. You can of course have interest only if you declare the property to be an investment, but that is higher rates.

With principal & interest loans, you still need to make the same repayment regardless of how much is in the offset account. The offset account simply adjusts how much of each repayment is principal and how much is interest. Even with the money in offset, a P&I loan will still be cheaper than an I/O loan in the long run. You can use your savings in the the offset account to make the P&I repayments (thus not affecting your personal cash flow).

 

Thanks Peter.

You got it correct. I don't have to borrow 80%, but I suppose most people do anyway?

Yes, I initially wanted to fix part of the loan, but I'm reconsidering now if I really need to fix it and pay that premium from now till the rates rise.

But good alternative options you provided. Thanks.

I found quite a few lenders show the IO options for OO still... I may reduce that to 400K IO VAR. Do you still think that lenders will reject this? My objectives are to preserve the tax deductible debts.

How will a P&I loan be cheaper than I/O in the long run? Assuming I have a 400k IO loan and I put $400k in the offset. Would this be any different to the P&I in terms of real cost?

As far as I understand, with the IO loan, I would be paying a single cent from day 1 (as I have $400k in the offset to offset against the $400k loan). Whereas with the P&I, with the $400k in the offset, I still have to pay $xxxx as minimum repayments, albeit the full amount going towards the principle.

I know that at the end of the IO period, the repayments will be higher, as the loan now will be paid off on a 25 year term instead of 30 year term... But other that that, what else do I need to be aware of?

Can you elaborate what you meant by the IO being more expansive than P&I please?

 

I think you'll find that many lender publish IO rates for owner occupied, but their willingness to do it is something else. Quite a few will do some amount, but there's a limit as to what they'll do. $400k might be possible, but hard to say. It depends on the lender and the reason you give them.

A loan that's fully offset isn't going to cost any different if it's P&I or I/O. You don't pay any interest either way so it doesn't cost any interest. Eventually you will have to pay off the principal though.

You've indicated that at least initially, you're going to owe $300k. on that portion, the I/O loan is a more expensive option on this portion for two reasons. The rates are higher for I/O and by not paying principal, the interest isn't going to reduce with each repayment.

Granted a I/O loan will save you on cash flow whist it it I/O, but after that expires, you'll still need to pay off the loan. This applies even if you pay off the loan quickly later. However you model it, if you compare the same variables, an I/O loan costs more because of the two reasons above.

 

Thanks again Peter.

I'm actually leaning towards this approach.
- 400k, P&I VAR with 100% offset. There won't be any money in the offset initially, but all savings will be put in here.
- 400k, IO VAR with 100% offset. I will put $400k in the offset.

Pardon my slowness in trying to understand, but I still cant grasp how the IO will be more expansive.

For the life of the IO loan, I won't be paying anything right? Since my offset has $400k against the $400k loan. And when it converts to P&I, each month, it will just draw down an amount (of which, 100% will go towards the principle) from the $400k I have in my offset. So... as far as I understand, IO or P&I, I won't be paying more either way. Am I missing anything?

 

Depends on the circumstances and what you intend to do.

You could borrow $800,000 or 80% LVR split into 2
$600k interest only with offset. No repayments if $600k in offset
$200k could be IO or PI depending on rate. perhaps have a second offset.

If you mean $600k before deposit then you will need to adjust.

Ideally you would borrow 105% and do the same.

Terryw’s Ideal Loan Structure Terryw’s Ideal Loan Structure

 

@wjw I'm talking about the part of the loan that isn't fully offset. There is a bit more to it that this, but the fact that the interest rate is higher and you do pay interest on this portion (because it's not offset), means that it will cost you more.

 

Ah got it... Though the part of the loan that isnt fully offset is P&I and hence the interest rate is as low as it can get. 3.6x%