Purchasing IP then PPOR - P&I vs IO difference/mortgage strategy?

Discussion in 'Loans & Mortgage Brokers' started by Jimmy C, 2nd Mar, 2020.

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  1. Jimmy C

    Jimmy C Member

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    Looking for some advice regarding the optimal strategy going forward - first purchase so eager to learn from the best!

    My aim would be to purchase the investment property (IP) and therefore maximise tax deductible debt, then afterwards purchase another property with likely the intention of living in the long term. Would consider making the 2nd property an investment before I live it depending on life stage (let's call it PPOR)

    Background
    1. Purchasing investment property (IP) $730,000.
    2. Capital depreciation schedule $7000/year
    3. Transaction Cost $35,000
    4. Current rent - $550/week
    5. Cash on hand $140,000
    6. Job where LMI waived for LVR 90%
    7. Tax rate 37%

    After the purchase of the IP, I intend to purchase another property (PPOR), with a combination of remaining borrowing capacity (approx. $400,000) and whatever savings thereafter. This loan will have offset attached to it.

    After discussion with a broker, he suggested a mortgage for IP as owner occupied (OO) P&I, LVR 90% with interest rate around 3.15% first despite being investment property due to interest rate differential. Other option proposed was OO IO LVR 90% at IR 3.8%. They have suggested LVR of 90% given high rental yield and P&I given the difference in interest rate.

    Question
    1. I feel like the crux of choosing between P&I and IO comes down to interest rate and subsequent financial difference. I have struggled to work this out accurately - can anyone suggest how to do this calculation? I worry about P&I due the rent being close to loan repayment amount and therefore loss of negative gearing.
    2. Can the mortgage for IP be an OO when it is actually and IP? My broker tells me that it should be fine, and the only difficulty may arise when seeking to borrow further, and that it just means I need to choose one to be OO vs investment loan.
    3. Given it is an IP, my feeling is that it doesn't necessarily need an offset feature - is that correct?
    4. Any alternative strategy that may work? I've seen Terrw's ideal loan structure but I don't believe it applies.
    Feel free to ask any questions for clarification - cheers
     
  2. Terry_w

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

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    1. Many have tried to calc and failed. me included
    2. Not without deception.
    3. not if you will have cash left over
    4. why not? You would want to borrow 105% for the IP and leave cash for the future main residence.
     
  3. Peter_Tersteeg

    Peter_Tersteeg Well-Known Member Business Member

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    I've done quite a bit of modelling around this. The answer really depends on your circumstances and financial resources.

    My thoughts are that you need a reason and some decent financial discipline to take an interest only loan. If it's just to save you some cash flow, then overall it's only going to cost you more money in the long run.

    An IO loan will save you a lot of cash flow in the short-medium term but it comes at the cost over the longer term. The trick is to do something useful with that cash flow. Pay off other debt, invest it in something else, this will make IO worthwhile. If it's only going to be used up in the expenses of living, then you'd be better off with P&I in the long run.

    I'm not an accountant, but accountants have reviewed my calculations. If you're doing it for tax purposes, I don't think IO is worthwhile.
     
  4. Rolf Latham

    Rolf Latham Inciteful (sic) Staff Member Business Plus Member

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    with the spread on IO IP rates becoming lower, for most high income earners that will have a bit of non ded debt, the real cost of PI on Ips is a wortwhile piece.

    Lets not forget that the PI component into the IP loan is a gift that keeps on giving until the non debt is all gone, and reverse compunds over time

    Perhaps get tax advice :)

    ta
    rolf
     
  5. croseks

    croseks Well-Known Member

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    Whether you go IO or P&I, only the interest component of your repayment is deductible not the principle. Also, you will have other costs and deductions such as property manager, rates, insurances etc..

    Eventually, the property will turn positively geared so this should not be your main priority as saving a bit of tax does not equal the wealth creation of compounded returns of capital gains.
     
    craigc likes this.
  6. croseks

    croseks Well-Known Member

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    Here is a simple cash flow analysis which helps when doing some back of the envelope type of calculations.

    Give it a go and maybe it might help you.
     

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