Loan Tip: Ticking Time Bomb of Interest Only Loans Expiring

Its not more than you can afford, its more that for the vast majority, they wont be making those 'principle' payments into the offset account, its going to nights out and a nicer bottle of red etc. From a system perspective any down turn in prices is going to be amplified if mr and mrs punter still owe what they borrowed 5 years ago and their house price is underwater.

About 10 years ago I saw loads of clients sold an offset account, or a LOC with the old credit card sweep scam who hadnt made any inroads into the principle for ten years and just wanted to switch back to a low rate P&I mortgage.

Maybe the lenders need to come out with an I/O loan with mandatory Principle payments to an offset account which are quarantined until they move out and change to investment. Itd get around the governments concerns, but wouldn't make the banks any money, or improve their balance sheets.

 

Thats fair enough, point taken but when lending IO on PPOR I've always had to stack up LVR's and income related to ALL loans, including IP's.
I agree, anyone wanting an IO loan without any other investments or collateral then to the P&I pidgeon hole they go.

 

The brokers who were saying those things when this started, misunderstood what APRA and ASIC were trying to achieve, but as the regulators and lenders have better communicated the reasons for the regulatory intervention, I think those brokers would now agree that these changes are here to stay for at least the medium term.

 

PM'd you

 

Just read the OP and trolled through the subsequent comments.

Whilst I totally agree with the what you are presenting Terry, I dont think its all doom and gloom... There will be opportunities to refinance with other lenders and keep the IO loan goings. I believe there is a greater good to be made depending on the returns of your chosen investment strategy. Being mindful of the IO loan maturing to PI etc..

Below are just my thoughts I had whilst reading your post.

Taking your numbers from the original repayments and say I have leveraged my $1M loan into property. Assuming an 80% LVR then you would be talking a property portfolio of approx. $1.25M (assuming you have already been able to cover the deposit and purchasing costs etc separate to this loan..). Should this property portfolio be rented out at 4% and say year on year holding costs (maintenance, property management etc..) are 1.5% then we are talking a 3.5% contribution towards the annual holding costs of that loan. So at year 1 that would be approx. $35k, so $15k out of pocket.

Come end of year 5 and assuming the property has seeing an annual capital increase of say 6% per year the value of the property portfolio would be ~$1.67M. Assuming the same rental return and holding costs, yearly contribution to the $1M loan would be ~$58k. Comparing that against the now P&I loan repayments of $70k you are out of pocket $12k per year with your equity having grown from $250k to $670k over 5yrs. By the end of year 8 the value of the property portfolio would have grown to ~$1.99M returning $69,650 per year in rent whereby covering. Hopefully I got all my maths right!

Just my thoughts as I mentioned.

Cheers

Thor

 

Thanks Thor

Since writing this thread I managed to help a client extend an IO term another 5 years, even though she was unable to show servicing. The loan had just completed a 10 year IO term. Hope she can do it again in 5 years, but even if she cannot she is saving up in the offset account and any effect on her would be almost unfelt

 

I hope so.....

 

I should clarify my statement here, I think too many people are overpaying for investment properties and accepting WAY TOO MUCH RISK for the yields we are seeing.

At the end of the day investors like us are "bankers" for renters, eg. we as "the investor" are backstopping people choosing to spend their money (or banked time as I prefer to call it referring to delayed gratification) either because their income doesn't allow them to save enough for a deposit OR because their lifestyle choices exceed their income at the moment in order for them to purchase permanent shelter.

At the moment my Gross ROI on property is 3.78% pre- expenses and Net ROI 2.82% post expenses (but before mortgage repayments).

Basically I am "delaying gratification" and banking my time with the view that the return over the long run is going to be greater than inflation, and the person renting from me is banking that their lifestyle choices are better served 'for now at least' by renting.

The problem I see is this, investors aren't being rewarded for the risks that we take that we aren't going to get shafted between the banks and the tenants.

Basically "property prices" are too high compared to the rental income ROI you are getting per week.

There can be two reasons for this.....too many investors OR lack of other opportunities.

There is exactly the same correlation between this and the current situation with the German bund yield or the other countries that are currently ZIRP.

It probably wouldn't hurt if we as investors started to "underbid" the market and forced prices to go down in both dollar amount but most importantly allowed wages time to go up....and for rents to catch up to purchase prices so that the yield on property rents were paying a higher return.

Of course the natural followup question is do I pay down my current debts with the excess cash OR do I invest it into other markets eg equities which with 17 & 21 p/e....suck equally as much but this is very much a first world problem to have.

 

How are you calculating you're ROI? Isn't the investment your deposit? Or are you calculating your investment as the purchase price?

 

Good point, I should be calculating return on funds invested, due to leverage, I was just using simple ROI based on return of market price I could sell it for today excluding mortgage payments (because then you would start getting distortions due to purchase dates/deposit amounts etc).

Just to be clear....you should never calculate on purchase price, only market price, otherwise time would demonstrate better than actual results.

 

This is probably 'yield' you are talking about Dean.

 

trouble is finding market price. Many would argue you cant have a market price unless you actually sell. A lot of companies and individuals got into trouble valuing 'at market' especially prior to the GFC. Most conservative investors value at purchase price.

 

I'd be very surprised if I couldn't get a "market price" within 20-40k of my guestimation, eg how else would I know if a place I'm bidding on made financially viable sense.

Sure if you never read the domain auction reports or you only have one IP etc then you might be out by a larger factor but after that....If you are paying attention you should be able to price a fairly good estimate and adjust it monthly/quarterly based on listings and results you observe.

 

How did you manage that?! Has she been saving the equivalent principle up in the offset? Is her strategy to inflate the principle away?

 

It was pretty easy - just asked for a variation.

She actually had been saving up in offsets, but with other banks and this wasn't considered.

Her strategy is keep buying using borrowed money and to keep saving in offsets.

 

I didn't actually know what length IO periods my loans were.

Quick phone call to the bank and all sorted.
PPOR - IO to Sep 2024 (was 10 years when changed 2 years ago)
IPs - All increased to 15 years IO (the maximum), some were 5 years, some were 10 years

Didn't even have to do any paperwork.

PPOR should be fully offset within 5 years, so worse case scenario I can't get IO again at the end of these periods I will have plenty of cash to pay the principle portion in the PPOR offset, thereby not affecting cashflow. Would give plenty of time (years) to sell a portion of the portfolio to pay out the remaining loans.

 

So its not all so doom and gloom; there is always an option to refinance to another provider.

That being said, i've just been in touch with my broker and he mentioned that if we shorten our IO period (from 5yr to 2yrs), then we are able to borrow a larger amount.
However every 2years; he is able to reset the IO period for us (what he does in the background i do not know). He does this for all his clients.
I have no reason not to believe him as his business is built on customer loyalty.

Can someone validate if this is true about the shortened IO period to allow for greater borrowing?

 

Yes it will in many cases.

This is because some lenders assess the repayments based on the loan term minus the IO term. So the shorter the IO term the longer the loan and the lower the repayments.

But there is a risk that in 2 years you will not qualify to extend.

 

The other risk is that lender will change their 'rollover' process sometime in the next two years and you have to move into p&i.

 

This is quite likely from the whispers I've been hearing for a while - it's likely to need a new application.