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?

I have many clients with fully offset investments loans. That is they have the equivalent to the owed amount in the offset account.

Due to servicing reasons they may need to change the loans to PI or pay down the loans or they may not be able to extend IO terms.

Most want to keep access to their cash to allow for earlier retirement but changing the loans to PI (voluntarily or involuntarily) would mean they are quickly paid off.

I wanted to work out how long it would take to have a loan paid off in these situations so I did some calculations.

Example 1
$500,000 loan interest only over 30 years.
$500,000 cash in the offset account
The repayments would be $0 each month
The interest rate would not effect the repayments at all because there is no interest. It wouldn’t matter if the interest rate was 5% or 50% (until the loan reverts to PI).

Example 2
$500,000 loan over a 30 year term
Interest rate is 5%
$500,000 cash in the offset
If the loan repayments were PI then they would be:
$2,684 per month
Because the loan is fully offset none of this repayment would include interest so the full repayment would be going towards reducing the principal of the loan.
Therefore to work out how long it would be for the loan to be paid off:
Loan amount divided by monthly payment = number of months to pay off the loan
In this example
$500,000 / $2684 = 186 months
This equals about 15.5 years

Example 3
Let’s do it with a different loan amount
$800,000 at 5%
Repayments would be $4,295 per month
This also works out to be 15.5 years

Example 4
Let’s try a different interest rate
$800,000 PI over 30 years
6% pa
Repayments would be $4,796 per month
This would result in the loan being repaid at 13.9 years

Example 5
Let’s assume the loan was IO for 5 years and is now reverting to a PI term of 25 year’s.
$500,000 loan over a 25 year term
Interest rate is 5%
$500,000 cash in the offset
If the loan repayments were PI then they would be:
$2,923 per month
This loan would be paid off in just 14.2 years

Example 6
Let’s assume the loan was IO for 10 years and is now reverting to a PI term of 20 year’s.
$500,000 loan over a 20 year term
Interest rate is 5%
$500,000 cash in the offset
If the loan repayments were PI then they would be:
$3,300 per month
This loan would be paid off in just 12.6 years


So, roughly, a loan would be paid off in half the time if the minimum loan amount was paid each year and the loan remained fully offset.

Aside
Interestingly with the loan balance decreasing the borrower will need to find another place to store the excess cash which exceeds the balance. They may have to start offsetting a second loan, if they haven’t already, and this will cause this loan to be repaid at a faster rate. The compounding of paying off loans will accelerate. This is an unfortunate side effect of being rich.

 

It seems the higher the interest rate, the quicker the loan will be paid off? In all the examples above, if interest rates were 8% or 10%, the number of years to pay off would be even shorter.

Would the examples still work, if the borrower uses the offset funds for mortgage repayments, such that there is no 'excess cash' but the offset falls in line with the loan balance falling?

 

Yes as the higher the rate the higher the monthly repayments. As there is no interest payable it would all come off the principal.

No change if the offset is constantly reducing in line with the loan balance. But if it dipped below the loan balance there would be changes as interest would start to accrue.

 

A few years ago, ANZ forced me to go P&I on one of my I/O loans and its Offset was full. I can tell you I was ****** off.

I agreed on the basis that they took the P&I payment out of the Offset and the principal component came off the loan balance.

From memory, it worked this way. They added the interest charge to the loan and took the P&I payment from the Offset (after reducing this payment with the Offset benefit). The net effect was the the loan balance and the Offset balance were both reduced by the principal component.

At least that is how I think it worked. I agreed to it as, at least it didn't impact my cashflow. But it did reduce my debt and cash reserves which weren't part of my plan.

Can't one do the same thing today?

 

Kierank that is how it works normally.

 

Yeah it is ridiculous that if you have money in the offset that you are forced to pay off the loan in half the time.

A more logical way to calculate repayments would be

1. calculate P amount
2. calculate I amount
3. calculate I_actual (actual interest paid when taking into account the offset/redraw, the same way interest is already calculated on an IO loan)

Make the repayment amount to be P+I_actual instead of P+I.

Then you are paying off a 30 year loan in 30 years.
Debt is being reduced exactly as much as a P&I loan is planned to be reducing it in the first place.

The government is happy because you are paying off debt.
The banks are happy because you and are not on an "IO" loan.
The customer is happy because his repayments are not unnecessarily higher than the repayments to pay it off over 30 years.

It would even benefit the banks more than now because the money loaned is loaned for longer so they get more returns.

Someone should clue in the banks. Why they don't already do this makes no sense other than they just never thought of it.

 

Luckily some banks keep readjusting the repayments to reduce the minimum where you are ahead. This would slow it a bit

 

Yes. Your monthly repayment would be $8 roughly,.

 

So what the banks are doing now is not normal?

I think in my case the loan was originally 30 years. We had 2 x 5 year I/O periods, leaving a remaining term of 20 years.

So @Terry_w, my P&I payments were calculated over 20 years. The loan would have been paid out over 20 years (and my Offset would have been fully drawn down over the same period), not 10 years as your OP is suggesting.

I am a little confused .

 

I don't know how that could work.

 

can't you just for e.g.

$500,000 and then put $495,000 into the home loan as withdraw and then pay P&I on 5K? hence having liquidity to withdraw but not necessarily simila flexibility like an offset.

 

This may be a solution. I am not sure how banks change minimum repayments when you are ahead on the loan. I think at least some of them would reduce the monthly repayments.

Good thinking.

 

Looking on a few home loan redraw facilities. i know some banks limit redraws to like 1-5 per month? could be wrong. Ease of access could be issue that is something to think abt.

 

@Terry_w

I think with withdraw there is the issue with purpose of the funds. if the loan is an investment, but you end up using the funds for other personal purposes would an issue. As that is why ppl get split home loans.

 

I did this with ING and repayments were still based off loan limit as rationale was that redraw funds could still be taken out. They need you to reduce loan limit if you want to pay P&I on 5k.

 

I think it's the way they calculate the minimum repayments. You would have to check with your bank but I am pretty sure they would treat the loan as not offset. By this, I mean they can see the funds in your offset account but those funds could be withdrawn or moved at any time. Therefore they must calculate the minimum payment based on no offset.

Say you have a $500,000 loan for 20 years at 5% paid monthly. Your monthly payments are $3,299.78. Now, with no offset, the way your minimum payment is allowed to the account is like this for the first month:

Payment: $3,299.78
Interest: $2,083.33
Principal: $1,216.45
Balance: $498,783.55

If you make the same payment for 240 months, your loan balance would be zero.

Except in your case there is no interest, so your breakdown looks like this:

Payment: $3,299.78
Interest: $0
Principal: $3,299.78
Balance: $496,700.22

If you keep your account fully offset and keep making regular payments for 152 months your loan would be fully paid down with $1,566.56 left over.

Technically, you could ask your bank to recalculate your minimum payment every year if you want to. That would reduce the minimum payment every year and keep the loan going for nearly 20 years. I am not sure if they would want to do this though.

 

I have one loan io only in redraw with only $50 bucks owing see the debits in cents if it was to be loan limit that would be 3k

 

Yes that is correct when you are on IO. When it goes to P&I, repayments would be based on loan limit.

 

I did call couple days ago before they said it will be p&i on 5k as the loan is paid down I see the loan amount - but not concerned as mine churns in 2021and curious how it works. @Terry_w any takes on this ?