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Principal And Interest Or Interest Only?

Discussion in 'Property Finance' started by Jamie Moore, 21st Jun, 2015.

  1. Jamie Moore

    Jamie Moore MORTGAGE BROKER - AUSTRALIA WIDE Business Member

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    I posted this on somersoft a while back - and thought it would be useful to paste into the new forum since the question is asked quite a lot. For a lot of the older forum gurus - this info is nothing new but hopefully some of the new members will gain some benefit from it.

    Principal And Interest Or Interest Only?
    When it comes to claiming an investment loan as a deduction only the interest portion of the loan is tax deductible. The principal portion is not. Therefore, if you have an investment loan, and you decide to pay off some of the principal each repayment, you're effectively reducing this tax deductible debt meaning there is less tax you can claim back.

    This can be a costly mistake for those who also have non-deductible debt (which many of us do). This includes a home loan on your Principle Place of Residency (PPOR), car loans, personal loans, credit cards, etc.

    If you want to pay down any debt it is this non-deductible debt that you should try and knock on the head first.

    So what's the ideal structure?

    Whilst there's no "one size fits all" approach to loan structuring - it's generally a good idea to have all of your investment loans set up as interest only.

    With your PPOR debt, there are two choices to consider. If you are a disciplined saver and feel that your PPOR may one day be turned into an investment property (and you go onto buy another PPOR), then it's best to also set this loan up as interest only.

    However, it's important that an offset account is set up against this loan so you can continue to make the equivalent principal repayments regularly into the offset account. The offset account is also a very handy place for parking any spare savings.

    Why is it best to have my PPOR loan as interest only if I think it's going to become an investment property? Because this debt will become deductible in the future so best not to reduce it now.

    Instead, you can place your money into the offset account which will reduce your PPOR interest repayments whilst the funds are sitting in the account. When this property becomes an investment property in the future, you can move the funds from your offset account on to your next PPOR. This way, you've increased your tax deductible debt and reduced your non tax deductible debt.

    The interest only with an offset account doesn't work very well for someone who isn't a disciplined saver and will be tempted to simply make the minimum interest repayments.

    If you're not a disciplined saver and have no desire to convert your PPOR into an investment property at some point, then it's best to have a principal and interest loan on your PPOR. Once you've paid off your PPOR loan and any other non-deductible debt, you may wish to start paying down your investment loans.

    So in a nutshell, interest only for all loans with an offset account set-up against your PPOR loan can be a great overall structure particularly if you think you might turn your PPOR into an investment property at some point and purchase another PPOR. On the flipside, if you have no desire to turn your PPOR into an investment property down the track and you are not disciplined with money- then it's best to have interest only against all investment loans and principle and interest against your PPOR.

    PLEASE NOTE - this information is of a general nature. Please always consult taxation professionals about the specific nature of your situation. Some lenders are also moving away from allowing interest only against a PPOR - so be mindful of this when sourcing finance.

    Cheers

    Jamie
     
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  2. Bran

    Bran Well-Known Member

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    Jamie,

    Can you see much of a downside in a temporary PI when you know a refinance is imminent, and you've targeted a particular property for your redraw? lowering the LVR, allowing more for a new loan/deposit, will simply lower the loan for the next property.

    No available offset, and more concerned about a next purchase than paying down non-deductible debt (which is at an all time low)?

    Kid distractions tonight. Hope that makes sense
     
  3. Jess Peletier

    Jess Peletier Mortgage Broker - Australia Wide Business Member

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    You could - but why not put it in your non-deductible loan, redraw from there with a new split and debt recycle?
     
  4. Redwing

    Redwing Well-Known Member

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    Next question and with rates at historic lows being, "Fixed" or "Variable" ?
     
  5. TyroneS

    TyroneS Well-Known Member

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    Thanks Jamie. This is an awesome post as I've been struggling to understand why having an interest only loan would work. After reading your post I now understand there's benefits for tax. I just though by having an interest only loan meant that I park all my money in an offset and have access to it anytime rather than locking it into the loan by paying the principal.

    Also are there really any benefits to paying off your PPOR? As it can take as long as 30 years with say a loan of $700K if one was to buy in Sydney?
     
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  6. Jamie Moore

    Jamie Moore MORTGAGE BROKER - AUSTRALIA WIDE Business Member

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    Definitely.

    For borrowers who aren't disciplined with money - P&I is the best option because otherwise they may be tempted to make the minimum interest repayments and blow the cash elsewhere.

    Also - if you're quite certain that you won't turn your PPOR into an IP at some point, then I'd go with P&I and aim to get rid of the debt.

    Cheers

    Jamie
     
  7. Jess Peletier

    Jess Peletier Mortgage Broker - Australia Wide Business Member

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    Depends on your situation. If the lack of flexibility that fixing brings isn't an issue you could consider. There can be a place for it - locking in cashflow would be one of them, perhaps. However, there are so many disadvantages to fixing that I'm reluctant to ever strongly recommend it.
     
  8. TyroneS

    TyroneS Well-Known Member

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    Thanks Jamie.

    One of the goals my wife and I have is to purchase another PPOR in Sydney with a max budget of $850K, but with the prices so high it seems quite unaffordable. I'm wondering if it's a wise move to invest into buying property interstate first and build a portfolio first, then in a few years down the track to sell / or draw equity from the CG to buy back in Sydney?

    This is the part of the strategy that I'm getting stuck on because I'm not sure how much I really need to afford to buy back into Sydney again...

    Hope that makes sense?

    Thanks,
     
  9. Jess Peletier

    Jess Peletier Mortgage Broker - Australia Wide Business Member

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    My thought is also to 'pay it off' into the offset. I don't see the point of reducing flexibility - so much can happen in 30 years, that to say it will 'never' become an IP is just tempting fate :)
     
  10. sash

    sash Well-Known Member

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    Interest Only or muerto......PI is such a waster....
     
  11. Pistonbroke

    Pistonbroke Well-Known Member

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    On principle I'll pay interest and out of interest i'll cover the principal.
     
  12. albanga

    albanga Well-Known Member

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    I said this in Jamie's past post on SS but the only benefit I see in paying down PPOR debt is as Jamie has said if you are not disciplined. In every other situation IO is better. Simply put it becomes YOUR money.

    ScenarioA - Pay down principal but have no savings and then get injured (and assume you don't have good cover). How can you access money if it's all in your equity? Your not working so how can you pay the loan or service a loan increase? If instead you were IO then you would have the cash to live on without asking the bank if they can help you.

    ScenarioB - USA GFC crash. Say you had a 300k home. P+I you pay it all down and have no debt but then the market crashes. Your home is now worth 20k. Yes you have no debt but you have no equity either and what happens if you lose your job in that tough time? How do you survive?
    Flip that over and say you went IO and put it all into offset. YES you still have a big 300k debt but you can easily service it and whether the storm even if you lose your job. What's more if your a savvy investor you could capatalise and go and use some of your savings to buy 5 properties. Don't worry about the banks, they have closed shop, your going to be paying in cold hard cash anyway.
     
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