PI vs IO 10yr analysis

The problem is lost deductibility.

Running IO you could save a deposit in the offset that can be used the exact same way as described, except there is no need to meet serviceability to use the funds, and you can use them for non-investment purposes without reducing the overall deductibility of the loan.

As well as increasing cash-flow as the offset increases, so accelerating saving.

 

Exactly.

Recently we bought a new car for cash.

Just withdrew the funds out of our IP’s Offset (didn’t need the bank to approve the withdrawal), bought the car and now the interest is tax deductible .

 

All well and good UNLESS property value decreases/serviceability changes/income decreases/policy around cash out changes

 

Surely that would NEVER happen .

... unless we are hit with a global pandemic .

 

These arguments are short term only. They don't hold up well in the long term.

Have you actually put a dollar figure on the gearing? It's less than the extra interest on an IO loan.

Increased savings only a limited argument. The increased equity creation of P&I is greater and the savings of IO is significantly lower after the IO period ends.

 

I was in favour of PI investment loans for a bit, but now am swinging back to IO loans generally - unless serviceability demands PI

 

If someone has non-deductible debt, does it not make sense to put the deductible debt on IO and use the additional cash flow to pay down the non-deductible first?

 

That’s what I’m doing

 

Or even better, have an Offset linked to the non-deductible debt (preferably an IO loan) and use the additional cash flow to build up this Offset’s balance.

Especially if this property becomes an IP later in one’s investment journey.

 

Sure, interest rates and sevicabiltiy being equal, IO is superior. The problem is they currently aren't.

It is easy to do a side by side direct comparison after 5 or ten years, but how do you quantify less certain things like the opportunity cost? If having all your loans on P&I boosts your serviceability enough to get another IP across the line sooner how much is that worth?

It is a tricky question with a lot of variables specific to each borrower. Do you have non-deductible debt? Are you acquiring or consolidating? Are you cashflow constrained? What's the long term plan for the property etc etc.

 

Perhaps when getting into the property market it could be a vehicle to accelerate accumulation.
Even more so if living there, as saving your deposit in your offset increases cashflow, and compounds the larger your offset grows.
If there comes a point in time where serviceability is impacted, then swapping to P&I could be considered.
Is it just a matter of asking the lender to swap from IO to P&I without serviceability being re-assessed (assuming there is no fixed term loan in place)

 

And to assume whatever one is redirecting the funds to is actually performing better than the result of real estate investment. COVID19 is a reality check.

 

Hi Peter,

Do you have a copy of this calculator? I just want to run some numbers, or if you can run it for me. I want to see the difference between 2.79% IO vs 2.59% PI investment loan. I am still thinking IO would be the better pick here considering the spread is only 0.2% and directing the cashflow saving to non-deductible debt.

 

Please give me a call. I need a little more info for the calculator than what you've given.

 

What are your thoughts on using high yield properties with IO loans to fund long term capital growth plays that don't necessarily yield enough to fund all costs plus principal

Property 1: $500k, 7% gross yield, 0% CG yield (after inflation) IO loan
Property 2: $1m, 2-3% gross yield, 5% CG yield (after inflation) P+I loan

redirect the net cash flow (after interest, maintenance, insurance, rates) from property 1 to help pay for property 2

 

Thats what I do and after asking for a no trade price I ask the dealer to make the car as expensive as he can and give me the same change over price. (This gives more cash while maximizing loan) About a month after purchase go to broker to borrow against it, use cash from trade to cover deposit and first annual payment, pay one or two annual payments , 3rd or 4th year refinance balloon with another balloon payment. Use loan and remainder of cash to invest in shares like BAP and ARB which have been giving me 4% yeild paid back to LOC while the shares have 200% gain more than enough to cover the 30% balloon payment and finance on the next, car. Alternatively can trade in car to pay first balloon, and refinance a new car again.

 

Thanks Peter, you had an example attached with the difference of 0.4%. Happy to use the same example numbers you had, except using 0.2% difference in spread.

 

Generally seems like a reasonable idea to have a balanced portfolio of properties you can hold with SANF without knowing your personal situation. Your personal situation could change the answer significantly.

Note if you wish to remove inflation from CG calcs (as mentioned to use a NPV), you should also similarly devalue your debt against the properties as your loan amount also devalues for inflation.
Otherwise you are not comparing apples for apples.
Good luck

 

So many good posts, so well done.

My concern with the rolling interest only option, particularly due to tax deductibility, is that it is a very "present tense" way of thinking.

As an investor, I want to grow my equity, and I want the peace of mind to know that I can renegotiate with the banks and have some leverage when that happens.

It has its place of course, but IO structures and the benefits of current cash flow, does lead inevitably to a question about what the end game is: under the IO option, eventually you will need to sell the property.

 

It also acts as dead weight of every lender servicing calc - except Liberty perhaps - reducing borrowing capacity and therefore the ability to harvest equity and grow a portfolio. 10 years IO is destructive to borrowing capacity- simple as that. Didn't used to be. Is these days. If an investor isnt fussed by this, go ahead. But if an investor wants to make maximum use of available borrowing capacity, 10 years IO is not the way to maximise what you can borrow - unless you fancy using Liberty for every purchase, and paying a premium for the privilege. And every deal with need to 80% LVR or below...so you need to find 20% + stamps every time.

It may also create serious holding cost challenges in 10 years ; otherwise referred to as the "P&I Cliff" . Unless investors borrow well within their limits and have the ability to refinance or extend IO terms after 10 years, the repayment shock could be enormous if an extension or refinance cannot be achieved. While such a cliff has largely been avoided (this time) by emergency rate cuts , rate cuts have been exhausted, so it may not be something that can continue to avoided.... Unless we see #SPARTA .

But if SPARTA is not on APRA's radar, see points 1 and 2 above

You will note that the most passionate advocates FOR long term Interest Only tend to be investors who have accumulated all of most of their portfolio's pre APRA, when the opposite of points 1 and 2 were true. IO did not act as a dead weight to borrowing capacity and did not present refinance or IO extension challenges, meaning P&I holding costs were never ever a factor that had to be accounted for. Rather, IO improved borrowing capacity significantly ... massively actually as they bought each additional property and continued to utilise IO on each of them.... it allowed them to hold much higher ratio's of debt than today's generation can ever dream of being approved for, without ever having to worry about holding capacity. It provided such a significant borrowing and holding advantage compared to those starting out today, that it is impossible to take their arguments seriously when they continue to argue that the next generation can do what they did , just as they did it. It's akin to a marathon runner telling you that even though you have to carry weight on your back and stop after 10KM to jump hurdles and then possibly start the race again.... you can run the same marathon race they ran without having to do any of those things . Just utter nonsense.