Should I change to interest only?

Hey there,

Just looking for some pros & cons as to whether i should switch our P&I loan for investment property, to Interest only.

Current rate for P&I is 4.15%

Offered interest rate for Interest only is 4.55% (both CBA)

So, the loan is for 147k.
I have an offset with 120k roughly against this property.

Own PPI outright.

From everything Ive read, I am thinking I should switch to IO and keep the money in offset which should then mean I’m still paying down principal by saving on interest (or have I got that wrong?)

If this is the case, even when IO period ends, i should have still reduced my principle right?

I understand that by going IO does mean that you have essentially higher principal to pay over less time once period ends.

Thoughts?
Much appreciated.

Kate

 

Hi Kate, if you go IO, and have the loan mostly offset, you'll only pay the Interest on the loan portion that's not offset. You won't pay any principle off the loan at all, but as you save into your offset, the interest you pay will continue to be reduced.

If you manage to fully offset the loan, there will be no payment necessary - unless, you redraw from the offset, or the product flicks back to P&I.

The benefit of using IO is that if you ever need the offset cash for anything, you can grab it for whatever you want and maintain the current INV debt as deductible.

 

It depends

paying off debt is good as is saving interest.
But will you need the extra cash you would be using to pay off the loan if PI?

What about an alternative
IO $120k and PI the rest?

 

I don’t have any plans for the extra cash I’d save in monthly repayments right now to be honest..
I guess I thought Id be paying down the principal by having the offset as I initially stated in my post.. now i realise that’s not the case, sounds like I should leave as is until i have a plan for spare cash (ie buying another IP).

 

Thanks for explaining this to me.
I was also thinking about refinancing the loan as Im not convinced that CBA is offering a competitive rate (both PI and IO) considering my LVR and good serviceability.

Would many banks be interested in refinancing a smallish size loan like mine? I know a mortgage broker in the past said they wouldn’t take on a 150k loan application when i was initially sourcing it. (Because apparently they would only work with loans above 200k).

Thanks

 

@K8F even if you're buying another property I wouldn't be using your cash for this, use equity save the cash.
Cash is king, build it up in the offset account.

Old days definitely IO was the go, pump as much into offset. Problem is now IO rate typically higher than P&I
So now you can make the decision, given you don't have an PPOR debt likely best to keep P&I but only the minimum repayments. Also keep an eye out once you're level with loan balance same as offset - then would be looking to go IO as the rate is irrelevant

Any plans to upgrade the PPOR in the future?

 

You kind have answered your own question here... good LVR and servicing.... but loan amount small

4.15% is very good rate if you're talking $147k
4.05% is about the going P&I rate for borrowing $250k > $1M for new funds today.

So you're about 0.10% off with very small balance, you would likely struggle to get 4.15% today if you were apply for $147k of borrowing.

 

With a loan of $157k that's almost fully offset, there's unlikely to be anything to be gained by refinancing for a cheaper rate. The cost of moving will almost certainly outweigh any savings to be made.

The cost of refinancing usually runs to $700 - $1000. Grab a calculator and figure out what the annual saving of 0.10% with a loan $147k is.

Some will state that lenders are offering $2,000 rebates at the moment. The fine print states for loan amounts over $250k so this wouldn't apply.

For that matter, given you don't have any plans for the cash flow saving, I'm haven't heard an argument for switching to interest only repayments either.

 

Yes banks will definitely take your loan on Maybe it was just the broker who only worked with loans over $200k?

In your case, with the loan offset we'd do it but there would be a fee for service as the bank won't pay in this instance due to the loan being mostly offset.

But as others have said, unless you've got plans for more lending/getting equity out/doing more with your investments, there doesn't seems to be much need to move.

 

With those figures, you are paying interest on $27K.
Hardly worth the expense or effort of changing for a minimal saving.
Marg

 

Thanks I appreciate the input. As far as I was aware, CBA would allow me to swap to IO for no expense .. However you’re still probably right in terms of the higher interest rate for IO and minimal benefits in this scenario.

 

Ok, that’s been really helpful as I never considered the cost of opening a new loan etc.

Also, I guess I have been hearing alot about why you should make IP’s interest only loans. But on reflection after hearing everyone’s comments, perhaps its not so beneficial unless you use the $$ saved to pay off a PPR quicker or to buy another IP.

 

There's nothing wrong with paying off a loan, just do it in the optimal way. You've paid off your non-deductible debt so the the argument for interest only lending starts to get a little thin.

Granted interest only repayments would save you a reasonable amount of cash flow, but what are you going to do with that surplus? If you're going to invest it elsewhere, then that's a valid argument for interest only repayments. If you're simply going to leave it in the offset account to accumulate, that's pretty much an endorsement for principal & interest repayments.

You could argue that the money in the offset account might be used for a deposit on another IP in the future. Also consider that a fully offset P&I loan will still take over a decade to pay itself off (with minimum repayments). You're not really loosing much.

Also IO has a limited lifetime. Sooner or later the bank will make you pay P&I. The longer you wait to start paying P&I, the worse your future cash flow will be.