P&I or IO with large rate spread?

Discussion in 'Loans & Mortgage Brokers' started by Jaime, 22nd Mar, 2018.

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  1. Jaime

    Jaime Member

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    Hi Everyone,

    First time poster. I've been doing some research, but the answer is seemingly not as clear cut as I hoped in my searches, not mentioning specific rates and how big of a gap makes it worth it.

    We're in the midst of buying our first IP at $392K. We've been offered rates of 3.79% for P&I and 4.5% IO, neither fixed. The difference between the repayments will be roughly $400 a month, but roughly $200 will be a savings in interest. The cash flow isn't an issue, as it can be covered my our normally salaries without issue.

    I realize the tax deduction would be there on the higher interest payments (we're in the 39% tier) and we could potentially put that additional $400 to our PPOR mortgage and reduce our non deductible debt there, but is there ever a magic number where the difference in rate makes sense to do P&I? Is 70 basis points enough?

    Cheers.
     
  2. Rolf Latham

    Rolf Latham Inciteful (sic) Staff Member Business Plus Member

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    Hi Jaime

    is an option to find a lender where the spread is lower if you really want IO ?

    the "worth it " bit is hard

    for some, a spread of 20pts isnt worthwhile, for others 150 pts works because they cant hold the props on PI

    ta

    rolf


    ta
    rolf
     
  3. Property Twins

    Property Twins Mortgage Brokers & Buyers Agents Business Member

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    @Jamie , it's making more and more sense to pay off investment properties given the large differential in IO & P&I rates. As of last July, this differential was something like 3.88% P&I (which was fixed) versus a 5.5% IO variable rate! This differential is a lot lesser now!!

    Though since in your case you have a PPOR, I would personally prioritise paying that off (and in fact building the offset account), so you have reverse compounding effect on the non deductible mortgage.

    There is no right answer. However what the policies really would be in 5 years time? Your principal will be calculated over 25 years..

    Will come down to your goal. Some other questions to consider..
    * What do you want to do with your home?
    * Will it become an IP?
    * Do you want to continue expanding your portfolio and therefore cash flow is important, along with the ability to pay down non deductible debt so you can continue investing in deductible assets?
     
    Last edited: 22nd Mar, 2018
  4. Jaime

    Jaime Member

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    Thanks for the responses so far. In regards to another lender, we're using our existing PPOR's equity as cross collateral for 100% borrowing on the IP, so we can't switch lenders without refinancing our PPOR as well (which we just did recently).

    @PropertyTwins, lots of great questions - I almost booked that 30 minute strategy session was nearly booked this morning, but I thought I'd more research before wasting your time with lots of elementary questions :).

    Our primary home will likely stay our primary home "forever" - I put that in quotes, as who knows what will happen, but we have no intentions of keeping it. The yield would be too low for the price paid.

    Our main goal will be to continue increasing our portfolio, so eventually cash flow will be important. My wife and I do make good earnings with lots of extra money in our monthly pay, so to speak, but obviously we can't fund extra properties forever, especially with hikes in interest rates, vacancies, etc to plan for. Would making use of the lower rate and redraw facility back into our PPOR annually make sense? Just hearing back from our broker, she might be able to swing 3.59% P&I, so it's almost 1% in that case.
     
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  5. Terry_w

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

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  6. Property Twins

    Property Twins Mortgage Brokers & Buyers Agents Business Member

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    @Jamie - what's the reason for cross collateralisation. It's high risk you will find... Though keen to know what has triggered the crossing?

    I would recommend structuring it with focus on minimising risk from the start.
     
  7. Jaime

    Jaime Member

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    Mostly to tap into our equity to fund the new purchase. Buying the IP with no cash output from ourselves and have it be standalone and fund itself (it’ll be neutrally geared or slightly negative at worst).
     
  8. Property Twins

    Property Twins Mortgage Brokers & Buyers Agents Business Member

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    I understand. However, this can also be done without having to cross collateralise depending on the equity in your home.

    Based on your stated goal to continue increasing your portfolio, on the surface, cross collatralisation doesn't appear to be the most optimal strategy.

    Possibly rate is one of the driving factors here as you call out 3.59% - so there may be competing commitments re saving in interest vs building a property portfolio.
     
  9. Rolf Latham

    Rolf Latham Inciteful (sic) Staff Member Business Plus Member

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    xcellent that she can do that rate, but xcoll tends to suggest she is possibly not a full bottle on the risk vs the benefits.

    Xcoll is often ( but not always) the lazy brokers MO, vs most banks who like it simply for more control and ........ wow do they hate "split banking".

    Here is a post from 14 years ago........... much of that still applies, AND the folsk here I know can add at least another 6 why to avoid.

    To cross or not

    PI vs IO spread is a distraction perhaps ?

    just something to contemplate.

    And just as a final close, I have seen clients lose literally millions as a result of poor structuring when a lender didnt want to play ball anymore.


    ta
    rolf
     
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  10. Jess Peletier

    Jess Peletier Mortgage Broker & Finance Strategy, Aus Wide! Business Member

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    I highly recommend not cross securing your IP. You may still be able to get a really low rate on any OO debt and have the whole range of lenders to choose from for your IP loan.

    X-Coll seems simple but can cause WAY more problems than it solves.

    If you have to pay LMI, you have even more incentive to get it right before proceeding.
     
  11. Jaime

    Jaime Member

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    Thanks again for all the replies. As a general FYI, this is directly through a lending manager at a bank and not through a broker. I’m not sure that makes a huge difference, but it is direct. My personal financial situation is not the easiest and most brokers offered poor solutions in the past (Latrobe and similar), so this banker was able to work with us and achieve our initial goals easily.

    Moving on from that - what’s the best way to structure the first purchase and subsequent? We prefer not to put cash directly on the purchase, and both loans together would have us under 80% LVR, so we can avoid LMI altogether. I read your other thread Rafa and a lot of that makes sense, so we’ll look to undo this at some stage in the short term, unless there’s better ways to structure it now.

    Thanks again.
     
  12. Jess Peletier

    Jess Peletier Mortgage Broker & Finance Strategy, Aus Wide! Business Member

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    You may currently have a solution but it’s not a very good one - are you best off structuring poorly with a reasonable rate, or getting an A1 structure with a ‘possibly’ less great lender, but a long term plan that allows for future borrowing that’s also structured correctly? What’s actually going to end up more expensive?

    I don’t know the brokers you’ve dealt with but if a lending manager can help you, a broker also should be able to access the same product/lender unless they don’t deal with brokers at all.
     
  13. Jaime

    Jaime Member

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    That makes perfect sense and I agree, it’s worth doing right from the get go. Previous brokers all had issues as while I live in Australia, I’m self employed and earn income in a different country. Banks and lending agents seem to make self employed people jump through extra hoops, it was a double whammy with foreign income as well (and no ATO returns / NOAs to show as of yet).

    In a perfect world, what would the optimal structure look like in my scenario to fund this purchase? I just want to have a general idea so I know what answers to look for and what to stay away from for potential brokers.
     
  14. Jess Peletier

    Jess Peletier Mortgage Broker & Finance Strategy, Aus Wide! Business Member

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    Just don’t cross secure the properties. They can get the same result lending wise without crossing, it will just be split across two loans instead of one big one.
     
  15. Jaime

    Jaime Member

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    I guess I need to see the specifics of the loan documents to see if it's truly going to be cross secured or not. It will be 2 separate loans as far as I know. My PPOR will have a different rate to this and also has an offset associated to it, whereas the IP loan won't.

    Heading back to the original question - is a 3.59% vs. 4.5% rate big enough of a difference to warrant preferring the P&I?
     
  16. JasonC

    JasonC Well-Known Member

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    Jaime,

    Ideally it should be three loans ....

    Security PPOR:
    Loan 1 - existing loan
    Loan 2 - deposit for ip1 + purchase expenses

    Security IP1:
    Loan 3 - 80% off purchase price for IP1

    Each loan has only 1 security property. Could be all with the same bank.

    Regards,

    Jason
     
  17. Jaime

    Jaime Member

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    That makes perfect sense. So instead of actually using the underlying PPOR as a security, we're drawing just the amount needed for the deposit + expenses as a loan itself, and then having a separate loan for the IP. Thanks, I'll see if the bank can structure it that way.
     
  18. Terry_w

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

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    See
    Terryw’s Ideal Loan Structure Terryw’s Ideal Loan Structure

    Your banker works for the bank. It is his job to tie you up and get as much security as possible for the loan. It is your job to do the opposite.
     
  19. Terry_w

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

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    Ask about the all moneys clause too.