The IO property cliff disaster? Fact or fiction

I recall when lo doc and no doc got abolished, pretty much over night, many investors got cut at the knees. This was a disaster at the time, but seems like the savvy investors adjust and survive

this is another low blow and some tweaking adjusting required. Just have to mitigate the risks

 

Also worth pointing out that with P and I rates available with a 2 in front.....kinda makes IO a moot point for a lot of people.

 

The cliff was a real possibility, but so are a lot of things.

What would have made people unable to make PandI payments? Recession and higher unemployment. No buffer (whether savings or cutting spending). Higher rates. Falling prices. Unable to extend IO. IF all of these happened...... but........

Only the last one happened. Turned out most people managed the payments, interest rates fell, and some sold but not in large enough numbers to crash the market. There was too much focus on the multiple IP, always IO stereotype.

The US was supposed to have a problem with their resetting ARMs. The disappeared because rates went down.

 

On this I 100% agree....this warning is really important for people with large portfolios.

 

@kierank that's always been by philosophical approach. Understand and accept that there are things totally out of our control, plan for the things you can control, have risk measures in place and then move forward.


And...

Never, never, never EVER let the fear take over where you lose control and start mass selling, ignore fundamentals of what makes a good asset and start buying $10/week pos CF properties, start investing in other things (or suburbs) you have no clue about because property will crash or buy into someone else's investing strategy based on current market conditions etc.

The fundamentals never change. Ever. The cycles of fear, doom and gloom don't either.

The lesson in all this that I once again take away is, keep on keeping on, despite all the noise markets, media etc make from time to time. If successful share investors can do it where the sentiment swings are 100 times worse than RE, so too can RE investors.

 

I don't think people are getting how P&I works.

Lets say an investor has $2,000,000 in loans

1. If they have 25 years I/O rate of 3.75% they paying $6,250 per month

2. If they have 25 years P&I rate of 3.35 they are paying $9853 per month.

Are people seriously thinking increase $3605 per month or $43,236 per annum is not an issue. A lot of investors cannot refinance due to new servicing requirements. The impact is gradual...is loans convert from I/O to P&I. The issue is not over yet.....a lot of investors have a cash buffer it is when this is whittled down and once they have not other options.

The other factor is very few investors are getting P&I rates sub 3....mostly around the low 3 and mid 3s.

 

In reality, what proportion of all real estate investors would have $2m in loans?

 

You have done your repayments on 25 years for both IO and for P&I, but you need to account for 5 less years remaining on the loan term when calculating what happens as a loan reverts from IO to P&I. It would be more accurate to use 30 year loans for explaining this, with the first 5 years being IO , followed by 25 remaining P&I years.

$2 Million @ 3.5% IO over 30 remaining years will cost $5833 per month
$2 Million @ 3.5% PI over 25 remaining years will cost $10,012 per month

That's an increase of $4179 per month, or $50,148 per annum .

People who believe the P&I cliff has gone away, or that its business as usual, or that cycles never change, or that credit doesn't influence outcomes, are mistaken. They are making the classic mistake of believing that the recovery of the past 6 - 9 months is evidence of business as usual, and that the period between 2016-2019 was a glitch. They are mistaken. The P&I cliff has been deferred/cushioned, not avoided...and it has only happened because the RBA took dramatic and unusual action to bring the cash rate to historical and record lows.

Google any mortgage repayment calculator you like, and put the numbers in. The example below is $2Million @ 3.5% IO for 5 years, on a 30 year loan term. I have used the Westpac tool. Use whichever one you want - results will all tell you the same thing . Ignore cash flow and debt reduction considerations at your own peril, unless you believe the RBA has enough in its back pocket to kick the can down the road forever more. One day , most investors are going to encounter the situation below.... may not be today. May not be this year or next year or for many years yet. But it is inevitable. I'm just saying to plan for it, because the RBA doesnt have any powder left to save the day next time

The earlier you move to P&I in a 30 year loan term, the less the potential pain later on. If you go at Day 1of a 30 year loan term, the difference in repayments is far less than if you are forced to go after 5 years. Even going after 2 or 3 years is less painful than after 5 years , so I would just say that for those who can afford to migrate to P&I I would suggest you consider doing so...it avoids ever needing to face the kind of repayment increase outlined below.

Rates are so low now it makes sense to take advantage of them and pay down debt. It is good for your future holding power anyway , and good for your future borrowing capacity as well.

 

Quite a few in Sydney and Melbourne investors if they have a PPOR loan as well as IP loans. Lots on here have that much.....I know some with $5m plus.

I hit about $7m in borrowings at the peak if I pulled out all my offsets. I plan to have net (not including offsets) down to $3m or less in the next 2-3 years. This is on a 8 figure portfolio...

 

Even $1Million would mean finding an extra 25K. 500K would mean finding an extra 12.5K And none of it is deductible, as its Principle.

 

OK I used the CBA one...but I get your point...your scenario is even worse.

I took my lot my original loans out with 15 year and 10 years interest only. Thus why I am selling down to ensure my debt levels are almost paid off.

If people pay no heed...they could lose their portfolios!

Some people are thinking rents will cover their repayments in 5 years..that is highly unlikely!

 

The cliff is just another form of forced selling driving prices down. Same as expecting prices to fall if unemployment goes up or interest rates go up. People lose their jobs and have to sell houses all the time.

Lower rates, tighter lending (so people who have higher loans more likely accumulated prior to 2015, meaning more buffer and better cf), strong Syd / Mel prices means IO to PandI driven sales are fewer and more spread out, and more easily absorbed by the market.

 

Most likely only a small percentage would have such a small loan most substantially more.

 

Someone with a 500K debt that needs to find 12.5K extra if they had to move to P&I would need over 1K per month rental increase or wage increase. Somoene with 1Million needs double that, and so it goes.... I'm sure there are some who will manage to find the money, but unlike this time, where the RBA cuts provided a huge cushion by reducing the gap significantly, with rates now pretty close to bottomed there isn't going to be the same kind of cushion available next time large volumes of IO terms expire. The gap in repayments will almost all need to come out of higher wages or higher rents...

It was shaping up to be a sticky situation in 2015/16 when IO volumes exceeded 50% of all lending, but the APRA induced migration has been extremely successful in concert with the RBA reductions, and we are well below those figures now. The risk is that banks and regulators become complacent again, IO borrowers forget the lessons of the last few years as well, and ignore sound cash flow management...because the change to assessment rates has NOT gone away and the RBA has emptied its emergency bag , or close to it. So refinancing IO forever and ever is NOT going to be a given, and the cushion that was employed this time to soften the P&I switch wont be there next time.

It's all very easily avoided though if you account for P&I when you do your modeling. It's only when investors assume IO is always going to be available and can always be refinanced that problems can occur.

You can just see a future problem starting to form again, though.....

Mind the gap

 

Exactly.... numbers dont lie

 

This is very true and it does happen believe me.

 

How long did it take you to knock 60% off your debt ?

 

That can be fixed in one night at the Druitt local watering hole.

"Hey you with the disheveled look and funny accent.....cop this...."

 

it does not take many properties considering median of capital cities in Oz. I expect many on PC in this camp

 

On current net debt....I would say about 7 properties. I could take do this quickly but CGT would be massive. So need to manage over 2-3 years. Have another one about to go on the market in the next 2-3 weeks.

The possibly another one before the end of the financial year....depending on how much I make on the one I sell.