Paying P&I on IP loan compared to IO payments with offset?

I come across comments like this from tome to time on this forum:

"The first thing to do is stop paying P&I on your IP loan. That is costing you more than you realise - it's not a tax effective decision, you're much better off using IO payments with an offset account."

So, I've got 1 simple question, and it relates to tax only....

Lets say you have a loan (or a loan with an offset). Your monthly repayment is hypothetically $1000 for IO loan, or if your loan was setup as P&I, then your repayment would be $1100 (ie 1000 interest and 100 in reduction in loan).

Lets have a look at the 2 possible situations:
a. Lets say if it was structured as an IO loan and you pay the $1000 in interest and also deposit $100 in the offset). At the end of the month you principle that the interested is calculated on afterwards is the initial amount minus the $100.
b. Lets say if it was structured as an P&I loan and you pay the $1100 (ie $1000 in interest and $100 in principle reduction). At the end of the month you principle that the interested is calculated on afterwards is the initial amount minus the $100.

Both options a and b seem have the same outcome.

So aside from all the other stuff in terms of accessing your money from an offset or the loan, etc...., is there any difference in the tax effectiveness of either of the 2 scenarios?

 

There are two key benefits of IO vs P&I.

The first is that you have to come up with less money each month to keep the bank quiet. Accordingly you have the ability to service more loans (ie build your portfolio faster and enjoy capital growth on a much bigger piece of the property pie).

The second is that if you put money in the offset rather than hand it over and place it on the loan account, then you can withdraw it from the offset whenever you please for whatever you please. To use as a deposit on a new property. To buy a new pair of shoes. To go on a holiday. Whatever. You just withdraw it. You don't need to ask anyone's permission, apply or fill out a form.

 

@Jess Peletier as the original quote is yours, you might like to weigh in on this one

 

The question I am asking is specifically about the tax effectiveness only, and only in the constraints I have provided. Is there a difference?

 

Yes. The princpal of the loan will be reducing each month.

With the IO loan it will remain the same.

If you n

 

Also as the offset account increases the PI loan will be paid off faster.

The IO loan payments will actually reduce as the only thing being paid is interest.

However if you never take that money out of the offset the interest should be the same overall.

 

I understand the principle will be reducing, but over a period (eg a year) the same amoun of interest will be paid in both cases. So when you do your tax return, will there be any difference in the outcome?

 

Not if you keep the money in the offset.

Why not work it out with actual figures over 12 months and confirm.

 

Their is no difference to the net reduction in your loan.

The difference is your ability to move funds around at a later point in time if you rent the property.

 

You seem to be wanting a specific tax example.

I will give you one.

Let's say the loan is for what is currently your PPOR. You have decided that you want to buy a new PPOR and keep your existing PPOR and turn it into an IP to rent out.

Option 1 (You have paid P&I the whole time). You will be able to redraw on your currenty PPOR loan, and purchase the new place. It doesn't matter how much you redraw, none of the interest is deductable, no matter how you do it.

Option 2 (You have a IO Loan, so you still have a large loan, but also have a large amount of cash sitting in an offset)
You can use the cash that was sitting in the bank to fund the purchase of the new place. And you then move all of the cash to follow the new PPOR loan).
The net effect is that you have maximised the interest on the investment property and minimised the interest on the PPOR.

From a tax perspective, you have now created thousands of deductable debt to offset your earnings, which will save you $$$.

To take the example further.

It is now 15 years down the track, you have offsets on both loans that equal the amount you have borrowed (The loans would be paid off if you were paying P&I).

You see that shiny new sports car for 80k. You could get a loan for 80K, which will be non-deductable, or, you could pay cash from your IP offset.

Now you owe 80k on the IP again, the interest paid on this loan can be used as a tax-deduction.

Either way, you owe 80k. Just one way you can turn the interest from the loan into something that can offset your income.

 

And that is precisely the benefit of a offset. Technically the $80K was always owed.... you dont "owe $80K on the IP gain"... You always have owed $80K on that property. The interest on that loan is now restored.

 

There is only one problem here, you can't just stay on IO

And if your truly growing your portfolio, your going to be back to P&I at some point probably pretty quick.

You still use the offset though for extra.

Only those on large income can really think about staying on IO, you need the capacity to get to 100% offset, but then you back to square one unless you go out and buy again.