VIC Paying them down... or not

A mate and I both invest in our own property portfolios. We both have differences in opinions and strategies for the long term. My mate believes in working hard and try to pay down your investments is the way to go, yet I believe that having an interest only approach, maximising negative gearing (and doing it easier on the hip pocket). At the end we both have the same capital growth across our properties.

Assuming we are both invest in the same properties, have the same incomes and circumstances, would there be clear cut position on this one way or the other.

I am interested in the view of others on this?

 

If you own the same properties with the same capital growth then your friend would be paying less interest and so would be better off from a financial point of view.

I think the point of interest only is it frees up more cash flow to service more properties or other revenue making projects.

 

Depends on individual circumstances, lifestage, risk profile & where one is at in the investment journey. For me personally, my two favourite words are leverage and compounding, so it has all been about building largest asset base possible- so this means IO and not paying down non deductible IP debt. This may change down the track as I move into a different phase.

 

Depends on what your mate wants to do for retirement. I want to have all my properties paid off and live on the rent, supplemented by my super. So I am doing what your mate is and paying off my investments

 

The answer is simply it depends.

No different to , which is better.
Those that save for a rainy day vs those that live for the moment

 

Probably in today's environment the friend with the diligent history of saving and paying properties down might be able to get finance for the next property where as you may not (now that they are reviewing the details of each applicants spending habits)

 

Assuming interest rates are the same and the money that would have been paid into a PI loan is saved in the offset account then there should be no difference.

But the rates are generally not the same and people often spend the money instead.

But there can be substantial differences in retirement - the person who had paid down the loans may not be able to retire as quick as the person that built up large sums of cash. There would also be tax differences in retirement when the cash is used. I have written a post of this before - see strategies in my footer.

 

Thanks all for the quick responses. There is a lot of logic in what is being said in the above thread.

@Terry_w I will look at your previous post for other insights.

I think my rational of thinking has stemmed from looking at my first mortgage 36years ago of $22k on a $44k house and land, almost killed me to pay it off. However as that property had sold recently for $610k in MillPark Vic, I question why I busted my butt to pay it off the way I did. Capital growth surpassed any benefit of paying that down. It was my PPoR not an investment property and certainly no tax benefits (well no CGT). If that was an investment property though, my question would be does capital growth outstrip the benefit (and strain) of paying down the extra (say $20k of interest for the life of the mortgage) with the current benefits of negative gearing, etc.would that $20k come back in tax benefits the same period of time?

I have always viewed investment properties as a long term strategy and have had mine for the past 11 - 18years with overall portfolio growth near on tripling in that time. Does the debate change with the longer you have a property?

I do ask my mate the question of the purpose of having investment properties and we openly discuss the reasons.
1. to help fund retirement
2. to help fund a lifestyle
3. to help fund the kids when we move on....

I can comfortably answer 1 and 2 .... well with question 3.... I am trying to teach the kids "how to fish" if you know what i mean.

 

I would go with interest only and save as much as possible in the offset account. if you pay it back to the bank it's difficult to get equity back out once you hit the retire/semi retire age. if your mate completely paid off and if the rent does not sufficiently cover his retirement expenses/gift. he would need to reverse mortgage it sell off. that would not be an issue if the money is in the offset with IO.

 

The problem with building an IO portfolio is that it can be difficult to hold long term. If you're going to keep renewingIO terms you need to keep your borrowing capacity below a certain point which by default limits you to 3 or so properties.

Of course you then Have the option to get into other non-property investments but you need a very large income to build a huge portfolio these days. Paying them down will help over the long term to build a bigger portfolio.

 

all good points guys !
IO is always the "wisest" way and then hold the extra in offset accts. BUT;
In my experience with humans -we need to "feel" like we are getting somewhere too. I always recommend to people to at least pay down one or a few of their portfolio consistently while they are growing their portfolio as this helps us "think" we are getting ahead quicker -even if only a small amount each week

 

I 'feel' like I am getting somewhere by watching capital growth kick in. I don't feel a need to pay down a loan to have a sense of accomplishment. Each to their own I say

 

Definitely interest only for me as gives me flexibility to move the money around to different property offset accounts depending on which property I live in (or new purchases in the future).

Also Home loan interest rates are the lowest form of finance so could use that to buy shares instead of borrowing to buy shares where interest rates are at least double home loan rates.

Just opens up a lot of options and keeps things flexible

 

+1 to what @Jess Peletier said.


"A mate and I both invest in our own property portfolios. We both have differences in opinions and strategies for the long term. My mate believes in working hard and try to pay down your investments is the way to go, yet I believe that having an interest only approach, maximising negative gearing (and doing it easier on the hip pocket). At the end we both have the same capital growth across our properties.

Assuming we are both invest in the same properties, have the same incomes and circumstances, would there be clear cut position on this one way or the other.

I am interested in the view of others on this?


If you both have the same or very similar capital growth - your mate has more equity than you have because he is also creating equity through debt reduction. That's the first point of difference.

If you both have the same capital growth, and assuming you have similar incomes , other debts, dependents , credit card limits etc - your mate also has a greater chance of being able to harvest that equity to continue to grow/accumulate . This is the critical second point of difference.

Why is it so? It's simply because he will have superior borrowing capacity. And why is that so? , It's simply because of carrying less debt, which is now assessed at sensitised P&I rates of between 7 and 8% at most lenders AND a result of his debt being assessed as P&I over 30 years, where yours will be assessed at 30 years minus the I/O period. This means that if you are using 10 years I/O, your debt is going to be assessed at a sensitised P&I rate ( same as your mate - no clear advantage one way or another on this ) but over 20 years instead of 30 years ( not the same as your mate - he is clearly advantaged on this point ) and of course, you are also carrying more of it ( debt, I mean) so your mate wins on that count as well.

This didnt used to be the case in the pre APRA environment. It is definitely the case now though. I have said this many times before - investors are working with different ingredients now ( no choice...'tis what 'tis ) and just cant reasonably expect to be able to bake the same cake as previous generations using different ingredients.

So all other things being equal...debt reduction will see your mate better positioned in years to come because his equity position and his ability to harvest the equity will be superior to yours - but that only really matters if he intends to take advantage of that position.

Now, having said all of that...you didnt mention whether you and your mate still had non income producing, non deductible PPOR debt... if you do have this kind of debt , I would qualify/fine tune all of the above by saying that the following principle ( excuse the pun) comes first - always. Without exception. Always use I/O wherever you can, for as long as you can , to hold your INV ( income producing, deductible) debt. Attack all PPOR debt first. Pay it down.. and then migrate your INV debt to P&I and start paying it down.

 

I'm a big believer in paying P&i as technically you don't "own" the asset until you paid it off.

However, if I can start from the beginning again I might do all my loans as a LOC as I see this is the way to go which doesn't give you the headache to look for refinancing when I/O period is about to end. And at the same time allow you to hold on to the loan as long as you wish, with full equity access at any point in your life should you need it.

 

Very well said as usual.
The thing is, once you're in holding-mode, wanting to enjoy your life stage, IO makes it a lot easier to do so. Or at least, it did when IO rates were the same as, or similar to, P&I.
After living on IO for only a year and then returning to P&I, as well as paying off a small loan, I can honestly say "ouch!".
I now think the whole thing has gone too far and if it continues, a massive sell-off could result in the older generations being left with no assets. After years of investing, one would hope that you can use your own funds in an offset to do whatever you want.
My own bank is only offering variable IO at 5.7% which is still pretty good in the scheme of things but at this time, one wants to fix (with offset) where possible, like I did in 2015. I don't believe this climate is here to stay - way too austere and there's no GFC. I hope it changes soon.

 

As long as the bank wishes - most LOCs are not term loans but are at call. Higher rates too. and hurts serviceability.