Loan Tip: How IO Loans can Help You Retire Quicker

Discussion in 'Loans & Mortgage Brokers' started by Terry_w, 12th Mar, 2017.

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  1. Terry_w

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

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    How IO Loans can Help You Retire Quicker

    I wrote this article as a draft ages ago and think I should put it up before IO loans become extinct.

    There are 2 main advantages with IO loans that allow a person to retire quicker than if they had PI loans. The main advantages are:

    a) Lower repayments; and
    b) Building up a higher cash buffer


    Most people know that IO loans have a much lower monthly repayment than PI loans.
    Example $500,000 at 5% pa
    IO monthly repayments would be $
    PI monthly repayments would be $
    That is a monthly difference of $

    Paying PI would mean you need an addition $ in income each month. Assuming a 4% pa return this would mean extra capital needed would be around $

    The IO repayments means less capital is needed and the person could retire a few years earlier.

    Of course these days IO loans revert to PI at some point – usually 5 years and some 10 years so this needs to be planned for.

    The second point is the building up of Cash. The more cash you have the quicker you can retire as even if your income is not at the required level you can start to draw down on some of the cash to fund lifestyle. This is a form of living off equity, but it is not borrowing to invest, but using cash.
    This is tax effective where the PPOR debt has been paid off and the cash is stored in investment loan linked offset accounts. When you withdraw cash from an investment offset more interest is incurred, but this extra interest would be deductible
    Tax Tip 82: Taking money from an offset account on an IP and Claiming Interest https://propertychat.com.au/communi...-account-on-an-ip-and-claiming-interest.6012/


    This is tax effective as any additional interest is cushioned by the tax savings.

    This is also just a temporary measure to allow for earlier retirement as rents will, hopefully, rise so each year you will need less of your cash to live on.

    Therefore where the PPOR is fully paid off it can be a good idea to keep all investment loans as interest only for as long as possible – where you are strong willed and not tempted to spend the money saved
    But keep in mind that these days having the loans as PI may result in a higher borrowing capacity.
     
  2. Terry_w

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

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    The alternative view is that PI loans allow for earlier retirement because you are decreasing debt and thereby increasing profits.

    However the same decrease in interest can be achieved by using IO loans with an offset account, yet with great tax effectiveness when using the funds in the offset for living expenses.
     
  3. Simon Moore

    Simon Moore Residential & Commercial Mortgage Broker Business Member

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    Great post as always. I have never thought of living off equity like that before, Terry you are always expanding my horizons!
     
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  4. Sonamic

    Sonamic Well-Known Member

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    Great post Terry. Any chance you could populate the amounts listed?
     
  5. Terry_w

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

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    Lol.

    I thought it is just a theoretical example so the numbers don't really matter too much but I think it would be around $400 per month difference
     
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  6. VB King

    VB King Well-Known Member

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    If you can bag a reliable blue chip ~6%+ dividend payer then it may make sense to go IO and push that extra cash elsewhere.
     
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  7. Martin73

    Martin73 Well-Known Member

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    Example $500,000 at 5% pa
    IO monthly repayments would be $2083
    PI monthly repayments would be $2684.11
    That is a monthly difference of $601.11

    Paying PI would mean you need an addition $601.11 in income each month. Assuming a 4% pa return this would mean extra capital needed would be around $180,333.
     
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  8. Martin73

    Martin73 Well-Known Member

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    It's a strategy many retired parents :) are following:
    15 top dividend shares to buy in 2017
     
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  9. RickProp

    RickProp Well-Known Member

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    The view I have always taken is that with PI payments, you have no choice but to pay the capital portion of the repayment every month, with IO, you can CHOOSE to make this (assuming you are allowed to make repayments or have an offset etc).

    I always viewed this as a less risky approach as you have a bit of breathing room should interest rates rise, you lose your job etc. You also then have the ability to reinvest the excess CFs into further IPs, shares etc, so it gives you more options. I never go PI as far as I can avoid it.

    Get as big as you can (property wise :) ) as fast as you can whilst managing risk and CFs and you will be counting your big red hotels rather than piddly little green houses in the future!
     
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  10. Perthguy

    Perthguy Well-Known Member

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    Despite this, investors should still consider the possibility of capital losses and whether or not a company’s current dividend is sustainable.
    Good advice!
     
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  11. flyhere

    flyhere Well-Known Member

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    Thanks for the great post Terry-w! I wish I read it earlier...
     
  12. flyhere

    flyhere Well-Known Member

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    Smart idea!
     
  13. flyhere

    flyhere Well-Known Member

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  14. flyhere

    flyhere Well-Known Member

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    So much extra repayment needed!
     
  15. Ethan Timor

    Ethan Timor Well-Known Member

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    This is very true and I do the same but it's the 'managing the risk and CFs' bit that worries APRA and rightly so. Too many people don't have good money management skills unfortunately :confused:
     
  16. Andy316

    Andy316 Active Member

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    Does this still run true, given IO rates are about .5% higher than P&I? I understand the benefits of having more options for your cash in offset/invested elsewhere, vs paying down principal.. but is that difference in rates worth paying for that flexibility?
     
  17. Terry_w

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

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    IO will still result in
    a) lower repayments, and
    b) larger cash buffers built up

    even if the rate is larger.

    but these need to be considered together with the extra interest payable.
     
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  18. Pash81

    Pash81 Well-Known Member

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    If u get IO loans, does that mean the serviceability increases as the monthly repayments are lower? For example if I can borrow 100k with PI then will I able to borrow more than 100k if I do IO for 5 years?
     
  19. Terry_w

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

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    Generally the opposite as they will assess on the loan term less the IO period making the notional serviceability repayments higher
     
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