Join Australia's most dynamic and respected property investment community

New investors - I/O vs P & I and the lowest rate

Discussion in 'General Property Chat' started by MsAli, 1st Feb, 2016.

  1. MsAli

    MsAli Well-Known Member Premium Member

    Joined:
    18th Jun, 2015
    Posts:
    1,147
    Location:
    Sydney, Australia
    At 23 years of age, I never wanted to pay principal when starting out. Although it was accumulation stage and I didn't know what the investment journey held, I didn't know the benefits of just I/O. I just knew that I would rather save $$ than pay down the debt.

    Later on I understood the benefits of I/O:
    • Keeping tax deductibility
    • Keeping cash in offset to reduce interest repayments
    • Keeping cash available for personal needs / emergency / PPOR purchase
    So curious, what keeps people hung up on P&I? Is it an education thing - "You don't know what you don't know"?

    The I/O terms are pivotal and can be detrimental to one's ability to hold he portfolio when going P&I after the I/O term is over. So the shorter the I/O term the higher the risk.

    INTEREST RATE vs. OPPORTUNITY COST

    Secondly, I find it's easy to get hung up on the rate one is getting. A "high" rate can matter. However, keeping that aside, while in the accumulation phase, what is the opportunity cost?

    Two of the purchases for @monalisa and I were done in 2013 April & May; these properties were purchased at rates around 5.77% (secured credit cards against the property contributed to the outlay costs of stamp duty & solicitor fees etc). It allowed exposure to the market while a lot of lenders were offering below 5% at the time. The risk paid off with the Sydney market capital growth and the properties were re-financed once enough equity was gained.

    So what's the reason when many investors are going for the lowest rate when the opportunity cost means you may miss out on 150k-200k capital growth in the short to mid term?

    What has helped you move forward with your decision making? OR Are you facing analysis paralysis when moving forward - just because in your mind the rate is too high to move to and the opportunity cost too low?
     
    Xenia and EN710 like this.
  2. Mombius Hibachi

    Mombius Hibachi Well-Known Member

    Joined:
    1st Jul, 2015
    Posts:
    492
    This post is bordering on specious. Just because Interest Only works for you, that doesn't mean it's right for everyone.
     
    sauber, sumterrence and MsAli like this.
  3. Befuddled

    Befuddled Well-Known Member

    Joined:
    19th Jun, 2015
    Posts:
    251
    Location:
    Sydney
    A lot of investors do it to "tick the box". Not that many study it seriously with the view of building a large portfolio. Therefore, many simply don't think about the differences behind IO vs P&I in the context of building a portfolio.

    They may have gone to their broker and asked for the lowest rate product, and that's exactly what the broker's done. Unless the investor has a clear desire to continue to accumulate and plan a few steps ahead, all they can really do is use the "greedy algorithm".
     
    MsAli likes this.
  4. D.T.

    D.T. Adelaide Property Manager Business Member

    Joined:
    13th Jun, 2015
    Posts:
    5,595
    Location:
    Adelaide, SA
    Wasn't this a PPOR-only product from memory?
     
  5. MsAli

    MsAli Well-Known Member Premium Member

    Joined:
    18th Jun, 2015
    Posts:
    1,147
    Location:
    Sydney, Australia
    Nah. Could do IP also. LVR difference.
     
    D.T. likes this.
  6. melbournian

    melbournian Well-Known Member

    Joined:
    2nd Sep, 2015
    Posts:
    1,327
    Location:
    melbourne
    i like I/O over P/I as it gives flexibility. i move a lot into my IPs making them into PPOR hence the offset funds are always moved around which is easier taxation wise and also reduces the liablity on tax.
     
    Cactus, monalisa and MsAli like this.
  7. ellejay

    ellejay Well-Known Member

    Joined:
    19th Jun, 2015
    Posts:
    1,123
    Location:
    Kimberley and NZ
    "What keeps people hung up on I/O, is it an education thing?" How patronising. It comes down to personal preference, there is a recent thread which explains the reasons why some uneducated folk (who have seen what can happen when IO goes very wrong) discuss in detail. Most investors here just use I/O and that is their choice. Personally I have a large portfolio and want to keep my LVR below 70%. I don't do renos/developments/trades currently as locum work probably provides a better guaranteed income for me. I don't want to rely on organic growth, as it is not guaranteed to provide cashflow or a buffer. I see growth as a bonus. I am continuing to buy using P&I, I don't currently need IO but would use it if I needed to. I'm aware of very successful investors who have made millions whilst using this strategy.

    Having been around a while, and lived in a number of countries, I've seen the various unforseen factors that can unexpectedly impact on property prices and the rental market (including new government interventions). That doesn't mean I'm anticipating a catastrophe any time soon, but I like principle to be paid down. Investing is a long term game, for me value increases are a bonus.
     
    S.T, Wukong, EN710 and 2 others like this.
  8. HUGH72

    HUGH72 Well-Known Member

    Joined:
    18th Jun, 2015
    Posts:
    2,123
    Location:
    FNQ
    I like I/O and have all loans except one as I/O. What I'm interested in is how banks look at a paid down P&I loan verses a IO loan with a large offset balance? They look the same, the IO loan allows greater flexibility but does it come at the cost of decreased serviceability?
    I'm not sure of the answer as the major banks now calculate serviceability on based P&I at approximately 7. 5% anyway. The 10 I/O also has a negative effect on serviceability, maybe some brokers can expand on this.
     
    WattleIdo, Befuddled and MsAli like this.
  9. MsAli

    MsAli Well-Known Member Premium Member

    Joined:
    18th Jun, 2015
    Posts:
    1,147
    Location:
    Sydney, Australia
    @ellejay - thanks for sharing. Different view to what we tend to read here

    @HUGH72 - good point. With P&I assessment the game has certainly changed
     
    EN710 and ellejay like this.
  10. Cactus

    Cactus Well-Known Member

    Joined:
    18th Jan, 2016
    Posts:
    994
    Location:
    Melbourne
    Oh no not this topic again. It was only discussed a couple of days ago.
    To summarise other post.

    Some people like IO some like P&I some like both. Many ways to skin a cat. Ultimately most agree IO is more flexible. P&I works better for those with less will power as forced savings and also ensures buffer is being developed.
     
    Terry_w, neK, MsAli and 1 other person like this.
  11. ellejay

    ellejay Well-Known Member

    Joined:
    19th Jun, 2015
    Posts:
    1,123
    Location:
    Kimberley and NZ
    Agree, I said my piece on the last thread and would have stayed out of it if it wasn't for the comment that people who use P&I are uneducated. No disrespect to the OP but seriously, if you need to ask what the benefits of P&I MAY be then you don't know as much as you think you do.
     
    Random Username and D.T. like this.
  12. Cactus

    Cactus Well-Known Member

    Joined:
    18th Jan, 2016
    Posts:
    994
    Location:
    Melbourne
    I have to say it made me laugh and then my next thought was where is ellejay's reply. Lol it was bait to a croc...
     
    ellejay likes this.
  13. Rolf Latham

    Rolf Latham Inciteful (sic) Staff Member Business Plus Member

    Joined:
    14th Jun, 2015
    Posts:
    1,171
    Location:
    Gold Coast
    IO with 100 % offset = PI at borrowers option

    Have cake, eat it too/

    Unless one isnt good with loose cash around, then PI with an accelerated repayment plan can be more appropriate.

    With some lenders now pricing risk for IO over PI, and ASIC looming to control IO lending, IO may soon be no longer an option per se

    ta

    rlf
     
    Erida, Xenia, MsAli and 3 others like this.
  14. Cactus

    Cactus Well-Known Member

    Joined:
    18th Jan, 2016
    Posts:
    994
    Location:
    Melbourne
    By the way I don't think the OP meant uneducated as in stupid. I think it was meant as in unaware of the benefits. But either way I get your point.
     
    Bozley, York, Xenia and 2 others like this.
  15. neK

    neK Well-Known Member

    Joined:
    18th Jun, 2015
    Posts:
    1,277
    Location:
    Sydney
    My loans are all interest only.
    Earlier on in the piece, my PPR was P&I - deliberately. Because i wanted to the security of having it paid down over a 30 year period. So it was the minimum required for P&I with any excess going into the offset.

    Depending on the person and their ability to save, i would recommend P&I as its safer option for them... even if they are contemplating investing. Remember, most people talk about wanting to invest in property, but that's only because everyone else around them is talking about it so they want in on the action. Those kind of people coupled with poor savings history, P&I would probably be a safer bet for them.

    If you recommended a person go IO and they blew all their savings instead of saving it in the offset and had no cash buffer as a result, then had to sell, how would you feel about it? Especially if you could sense that their ability to save was poor.
     
    MsAli likes this.
  16. melbournian

    melbournian Well-Known Member

    Joined:
    2nd Sep, 2015
    Posts:
    1,327
    Location:
    melbourne
    No offence but it's a Strange way to look at it if u don't want to rely on organic growth which comes with population, economy or infrastructure growth or manufactured growth through renos and devs, that u're really only relying on ur day job to keep paying down ur loans or business income to keep paying down ur loan. Have u not used equity to purchase ?
     
    MsAli likes this.
  17. D.T.

    D.T. Adelaide Property Manager Business Member

    Joined:
    13th Jun, 2015
    Posts:
    5,595
    Location:
    Adelaide, SA
    A lot of people here just regurgitate things they hear.

    If APRA or ASIC want to restrict lending further, I'd put money on this being the next route. Most other countries don't do IO and I'd hazard a guess at most consumers not understanding them.
     
    ellejay likes this.
  18. D.T.

    D.T. Adelaide Property Manager Business Member

    Joined:
    13th Jun, 2015
    Posts:
    5,595
    Location:
    Adelaide, SA
    Makes perfect sense to me - her properties are cashflow positive meaning she earns money from them. After X number of cashflow positive receipts are coming in each week, one no longer needs to work. This is the opposite scenario of where you're paying (ie negiative cashflow) to hold onto your properties - trapped into your employment until the situation changes.
     
    ellejay likes this.
  19. Logan

    Logan Well-Known Member

    Joined:
    19th Jun, 2015
    Posts:
    146
    Location:
    Sydney
    @Rolf Latham Do you really think IO loans will be cut ? what about existing loans ? Do you think roll over will be harder ?
     
  20. Cactus

    Cactus Well-Known Member

    Joined:
    18th Jan, 2016
    Posts:
    994
    Location:
    Melbourne
    I hope not just more nanny to our nanny state. If used correctly IO and offset can be a great thing especially when used to focus on reducing ppor non deductible debt first. Rather than being forced to pay down debt evenly amongst a portfolio.
     
    THX likes this.