Using IO loans to create Cash Flow ?

This is my first post, been reading for a while and thought I would jump in with a post, hi

I am new to the Australian property market, New South Wales is where I am located, and was wondering if it's considered a feasible plan to invest in the property market using Interest Only loans to create more cash flow in the short term (5 years) ?

My investment experience is in the US, the mid-west in particular, and a lot of the criteria used to locate quality investments just cannot be applied to the New South Wales property market. What general sort of rules, guidelines, etc. are you using to locate a property to evaluate and analyse if it is even worth going further with to inspect, arrange to meet, and potentially purchase ?

Thank you, any responses would be appreciated.

 

That was generally the recommended approach until a few years ago. Things have changed slightly because
a) IO hurts loan serviceability, and
b) IO loans generally have a higher interest rate.

 

Thank you for your reply. Is it a strategy that you still see people using in spite of this ? Or is it just dead as a strategy now ? For example, I have always looked for cash flow as a priority in my portfolio, but looking at the numbers with a typical investment P&I loan product here I am not finding any deals to sink my teeth into, maybe I am just looking in the wrong places, I don't know. The only way I can see positively cash flowing on listed properties for sale is with an IO loan with rates on the upper end of 3%.

 

Yes many still use it.

 

It just depends on the scenario in this lending environment - if you want to preserve your capital and get a higher return with it elsewhere and it isn't going to stifle your future serviceability then well worth looking at IO.

Many people elect to do this and invest that additional cashflow into other investment classes (shares, ETFs, etc), or park those funds in the offset account against their owner occupier.

If that cashflow isn't going to generate return superior to the IO / P&I spread, or goes to "lifestyle" then perhaps better opting for P&I repayments and lower rate. Dozens of difficult variables!

 

Thank you for the reply. The strategy I was looking at was as you mention, going IO, with all the positive cash flow being put straight into an off-set account to reduce the interest payable over time, with the idea of building a reserve to have as backup for potential future vacancy, or for in the case at the end of the IO period transitioning to a P&I loan product.

In the example of using IO loans, and finding deals, is there a certain amount of cash flow, total number, percentage of purchase price, etc, typically used as a guideline to evaluate a deal ?

For example:

Example 1: Fletcher, NSW
Purchase Price: $545000
Currently Rented: $520 Per Week
IO Loan at 3.82%: $367 Per Week
Cash Flow Before Other Outgoings: $153 Per Week

Example 2: Cliftleigh, NSW
Purchase Price: $400000
Currently Rented: $410 Per Week
IO Loan at 3.82%: $252 Per Week
Cash Flow Before Other Outgoings: $158 Per Week

Obviously there are so many other factors to begin looking into, vacancy rates, repairs, potential growth, etc. But looking at deals from a strict cash flow perspective, and doing a very basic analysis of them, looking at them on the surface, would deals like this be something to begin to look further into ?

 

Most will look at it on % gross yield i.e. example one is 5%. Nett yield is also important too in case you're comparing a freestanding house with a strata titled unit that has more expensive outgoings. If your nett yield % is ahead of your loan % then happy days.

 

Curious Johnny,

Great post, thanks for the question.

There is a lot we don't know about you in terms of goals, age, income etc, but as a general comment I would note two things:

1) The cash flow from these two regional properties would technically be positive. But it wouldn't be positive enough to change one's life. And my suspicion is that the positive cash flow surplus while good, would get lost in day to day living expenses.

2) In regional areas you would be getting some cash flow, but low growth. So I would suggest P&I loan so that you can be growing your equity (ie your net worth) and focusing on this rather than focusing on the positive cash flow aspect.

That said, if positive cash flow is your priority, these look like reasonable deals. Happy hunting.