P&I or IO investment loans?

My wife and I have 4 positive cash flow properties that we have purchased during the last few years. We are hopefully going to settle on IP #5 soon, and purchase IP#6 towards the end of the year.

All of our investment loans are currently P&I loans, mainly because we thought that interest rates are so low, it may be a good time to pay down the principal. Our mortgage broker is a property investor and suggested we think about going IO.

What are the pros and cons, or are we looking at things from the wrong angle?

Opinions are most welcome

 

If you have non deductible debt you are basically throwing money away by paying extra tax.

But you can get lower rates with PI and you are paying down debt - but it would be best to repay non deducitble debt first.

 

See
Tax Tip 25: Only Use Interest Only Loans To Acquire Investment Properties Tax Tip 25: Only Use Interest Only Loans To Acquire Investment Properties

 

+1 for non-detectable debt.

Also say in the future you want to cash out for renovations (on investment property) or a deposit on another investment property, you now have 4 properties at 75% LVR, pain in the ass to get equity out of them. If you had them on IO and used an offset account to pool that extra money it's a lot easier to do.

Also if you want to take cash out for a non-deductible purpose you won't be able to claim the interest. Where if you had money sitting in an offset account, that interest that cash is now not offsetting, is still deductible.

Cons are - servicing is worse with IO periods. P&I forces you to repay principle, when using an offset account you can 'cheat' and take money out for holidays, cars and the like. Possible interest rate implications (does not apply to all lenders).

 

Main benefit is:
1. Tax if you have non deductible debt.
2. Borrowing capacity to build a portfolio.

Unpacking no 2 (finance side of things):

You may need I/O loans to maximise borrowing capacity going forward. What you will find is that your borrowing capacity with an individual lender will fall by going I/O, but your borrowing capacity to build a portfolio will actually grow.

This is because other lenders will be willing to allow you to borrow more if you have your existing loans with other banks set to I/O.

Banks work out how much you can borrow by calculating your income and deducting your expenses. Whats left over is used to determine your borrowing power.

On the expense side of things, a few banks insert the 'contracted' repayment your due to make on your existing loans into their servicing assessment. Because the P/I contracted repayment on your 4 IPs is much higher than it would be if they were I/O, this means they insert a higher expense repayment figure into their assessment and thereby reduce your borrowing power.

If your approaching a servicing wall and need to keep growing your portfolio, using multiple banks to do so is part and parcel of doing it. Going I/O allows you to expand capacities with those banks.

 

You must be doing pretty well to have 6 IPs on P&I.

 

Do you have an owner occ loan? If so - I'd pay that down first and keep the investment loans as interest only.

Once you've paid down your owner occ debt - then I can't see any issue with reducing the debt on the IPs. Personally - I wouldn't convert all to P&I (unless there was a significant rate saving). Instead - I'd look to pay off one at a time. To do that - you don't have to change the loan to P&I - just make extra repayments into the IO loan (or even better - just into a linked offset in case you need to access those funds again)

Cheers

Jamie

 

No, we don't have a PPOR/owner occupier loan at the moment. We live and work overseas and are non-resident for tax purposes and my employer provides accommodation. Our Australian income from the IPs is minimal as they are only barely cash flow positive.

However, we will be returning home to Oz permanently in Feb 2017, so obviously our financial and tax situation will change. We're trying to decipher the best strategy for us, loan types and ownership structures (trusts?) to minimize our tax obligations when we return to Oz in Feb.

Can anyone recommend a propert savvy accountant we could contact?

 

A property savy lawyer perhaps!

Since you will be coming back to buy a main residence you might want to preserve your cash so that you have more to use for the main residence and higher deductions on the IPs.

 

@SirDingo General advice only, but before you start a trust seriously consider if you need one at all. I deal with a lot of clients who were talked into starting family trusts to invest when it's really not needed, one trust actually had an accumulated tax loss of $200k sitting in a trust, she is earning $250k+, that's a lot immediate cash flow she has lost.

What they don't explain is it has impacts on land tax (at least in VIC not sure about other states), reduces options of lenders and you can't easily use that property's equity to support investment outside the trust.

Most people don't properly understand what is required to maintain a trust, this can cause issues down the track.

For example, a couple I did the finance for a couple were getting divorced, they had 3 trusts between them, they were each trustees and the female partner's sister was the appointer of all the trusts. This help up finance for easily a month while Deeds of Amendment were produced to remove trustees and change appointer, it was a huge mess.

I guess what I'm saying is, don't just jump into a trust because everyone else is doing it, or your lawyer/accountant says it's a good idea (which they will always say, they want those fees)!

 

If any one is interested in VIC a trust will normally be hit with an extra ~$1500pa on $500k taxable land value, ~$3500pa on $1m and ~$6000pa on $1.8m,

 

Just last week I talked a forum member out of a trust which the client wanted to set up to own property in victoria.

 

Quite obvious if you have non-deductible debt but if you aren't carrying bad debt, would your advice change?

(The eventual outcome being debt free without having to sell off any property to be debt free).

 

If you want to be debt free then you have to pay down loans.

But why be hung up about being debt free. It would be more tax effective if you had a $1mil investment portfolio with $1mil in an offset account against this.

If you bought an ivory back scratcher usin the money in the offset the interest on this would be deductible.

 

How?? I'd still be paying zero interest & claiming the cost as a once off rather than spending $$ to claim an expense.

 

Say you wanted to retire early and before the passive income was at the desired level. You could then drawn down on investment offset accounts (even if you had other cash) and the resuling increase in interest on these loans would mean it is deductible.

A more tax effective method than living on equity by borrowing.

 

I am a self-funded retiree with multiple IPs, multiple IO loans and multiple Offset accounts (all currently full with our hard-earned cash).

Any time we have a major expense such as a holiday, a piece of new furniture, etc, we can paid for it out of one of our Offsets and the interest is tax deductible. Can't do that with a redraw from a P&I loan.

 

Imagine borrowing to go on a holiday and being able to claim the interest. That is what you can do. indirectly, with this method.

 

You can always go IO and get an offset account and chuck the principal in there instead. Same thing except gives you more flexibility to draw down your cash should you need it.