Variable or interest only loan for first IP

A friend and I are looking to buy an apartment in Melbourne for about 300k together and rent it out.

If we don't get in now, we may never do it

In the current environment is a variable loan the way to go?

Know where we could get a good deal?

The contract is signed subject to finance approval by this Fri so need to be quick.

Thanks!

 

Interest Only ( instead of Principal and Interest ) is the usual approach for an Investment Property.

If the loan is variable rate you can generally combine it with an offset account and additional repayments to help reduce interest outgoings.

You also have the choice of a variable rate loan or a fixed rate loan. A fixed rate loan will lock you in with a lender at a set rate and you face potentially significant break fees if you need to sell. This also prevents refinancing without a penalty.

Current discussion is that there may be another 1 or 2 rate cuts following the rate cut announced last week. Not all banks are passing it on. Many not in full and many are penalising investors by reducing the rate cut for investment loans. If you fix you will miss out on additional rate cuts. Flexibility issues aside, if you can find a good fixed rate below the variable rate then it is worth considering.

It's also worthwhile having a buffer of cash in the offset account to cover unexpected maintenance. Size of the buffer is a personal choice. $5k is enough to cover most major maintenance issues and several weeks with no tenant.

If your loan is fixed, just keep the cash buffer in a regular transaction account.

Sorry for the rambling post, but there are a few things for you to think about.

 

Depends on what your requirements are.

Generally speaking - a variable interest only with offset will provide the most flexibility. Variable rates are reasonably low at the moment - as are fixed.

With fixing - my general advice is to only fix if you require some certainty in what your repayments will be (not to beat the variable rate). The issue with fixing is that fixed loans are generally inflexible (usually can't link up an offset, etc) and are expensive to break if you sell/refinance.

If I were purchasing with a friend - I personally would want flexibility with my loan so I'd opt for a variable set up. I'd also look to split the loan into two. Whilst you'll both be liable for the entire debt - assigning one loan to each borrower can make life a bit easier for yourselves when it comes to working out repayments, etc.

Cheers

Jamie

 

If its an investment (and/or you have owner occupier debt or will likely have it in the near future), its probably a good idea to have it set up as I/O. Jamie's point about splitting the loan to keep track of it all is a good one for purchases with friends.

Re jointly owned properties, probably a good idea understanding the costs/benefits from a finance point of view. If you plan on going solo after this purchase, your borrowing capacity may be impacted quite sharply with the majority of lenders (half rental income, full debt used in calcs). Having a chat to a broker so your fully aware of what it means to you going forward is a good idea.

Generally speaking, its usually good having an exit plan before entering into joint purchases.

Have seen many of these go well and many not so good when life circumstances change requiring a sale/etc. The ones that go well are usually with a set exit plan and timeframe.

 

Rates are so low at the moment that it's difficult to imagine that they'll go much lower. In theory this would make it a great time to fix your loans.

I had the same thoughts when rates went below 6%. Then again when they went below 5% and again at 4.5%. I guess I was wrong on each of those occassions.

In reality I don't have a clue if rates will drop further, or when they'll start to increase. I think anyone who says they're certain of anything beyond a few months is fooling themselves.

Better to look at your overall budget and ask if you can afford for rates to increase. If the answer is no, then fix. Also keep in mind that fixing commits you to that loan for that period of time. It makes moving lenders or selling the property potentially expensive.

 

The best advice is to speak to your accountant first

With Principal & Interest payments you are at least paying down the loan but if servicing the loan is an issue or you are paying too much tax then interest only may be the way to go

 

The highlighted portion isn't really true.

An interest only loan gives the borrower better cash flow certainly, but under the criteria of most lenders, your borrowing power is actually reduced with an interest only loan. This is because lenders assess the affordability based on the remaining amatorisation schedule after the interest only period has expired.

Additionally paying too much tax is a very strange way to think because it means you believe you're making too much money. Reducing tax means somewhere you're loosing money.


The best structure for a first time investor with no other debts is generally to have an interest only loan with an offset account. The offset account allows you to use your savings to reduce the interest on the loan which will improve your cash flow. At the same time it keeps personal savings separate from borrowed investment funds which will give you more tax related flexibility in the future. Keeping your personal savings separate from investment loans is a very important tax consideration.

The loan does need to be variable to accomidate an offset account, but if you're more interested in fixed loans, it's fairly simply to split the loan into a fixed and variable combination to get the best of both products.

 

Thanks for everyone's input!

Originally my friend was going to buy the apartment on her own as a PPOR, but her application was rejected because the title is on company shares which effected the LVR requirements of the bank. I wouldn't be able to get in the market if it weren't for a friend willing to go halves with me, so we decided we could afford the apartment under a joint application. Since my friend had already signed the contract subject to approval by this Friday we are going with a basic loan just to get the approval, after which, the broker advises we can talk specifics and flesh out a loan suitable for our needs to be finalized by settlement.

We want an investment IO, split loan w variable rate, but the investment loan excludes stamp duty concessions which means we'd need a bigger deposit which we don't have and if we don't get in now, it may never happen!

So we've had to go with a PPOR loan to get our feet in the door and one of us will have to live there and pay the other person, if they don't live there, half the rent.

Do you agree this approach makes sense? Is there any advise on how to navigate this please?

 

I purchasd with my brother and we split the loan based upon our varying deposits. One thing that was super beneficial was going with a lender that allowed multiple offsets, one offsetting each other's portion (Bankwest).

Not sure all lenders have this feature so speaking with your broker make sure they check it out. You can also set online banking to hide each other's seperate offsets.

 

For investment purpose - interest only all the way.

In terms of a purchase between friends, I'd be very careful with this. The way most lenders treat debt servicing, a joint purchase like this can significant reduce both you and your friends borrowing capacity indefinitely. Likewise there is the ongoing issues of investing with another party.

 

Curious as to why interest only would be better than P&I... I guess it would make sense for a capital gains strategy but not so much if you were purchasing property for yield?

 

Interest only gives you more flexibility. You can redirect the excess cash flow to reduce non deductible debt first (PPOR mortgage, car loans etc).

Even if you have no non deductible debt, the additional component can still be placed into an offset account, providing the same effective benefit of P&I, but retaining the flexibility of being able to use the funds for any reason without causing potential tax issues.

Investment is a long term game and we can't predict our futures, structuring your lending to be as flexible as possible means you can adjust to changes in your circumstances with as limited issues as possible.

 

You can still make extra payments on an interest only loan. You can pay any variable loan off as fast as you like regarless of the payment type.

As Corey says, the difference is flexibility. With P&I loans you will pay the loan off over time. With interest only, it's your choice.

Combine an interest only loan with an offset account and a good savings discipline and you can not only reduce your repayments dramatically by saving money in the offset account, but you'll have far more options for those savings will will be far more tax effective for all sorts of scenarios in the future.

 

It's deductible, so no rush to pay it off.
One of the things I wish I knew a lot earlier on.

 

Wonderful advice

Is it possible to get a split loan where my friend has P&I and I have IO?

 

You can, but do note you're still on the hook for their portion, either as a co-borrower or a guarantor. There's one lender which will do a split loan which gives each individual their own statement, loan account etc, but you're still cross guaranteeing each others loans.

 

Be wary in doing this, as circumstances will invariably change in this situation.
This not to see that it straight out shouldn't be done. Definitely a split loan with an agreement about tapping into future equity.

It would be good to look at a lender which will have a "common debt reduction" policy in the future - whereby 50% of existing joint debts and repayments can be factored in to the assessment of a new loan. Which will make it much easier for one borrower to purchase solo in the future, if need be.

 

Joint ownership can work with someone as long as there is an exit plan.
A buy and hold amongst 2 single friends though is a recipe for disaster.

 

Do you mean having an offset account, so that determining tax deductibility doesn't become a nightmare?

And does IO+offset+no debts balance off with "your borrowing power is actually reduced", would having IO work against you when borrowing for a second, third, etc IP?

Cheers

 

That's getting fairly technical with a lot of possibilities.

Fundamentally an offset account keeps money saved separate from money borrowed. This is important because when it comes to determining what is tax deductible you don't want to be mixing different types of money or money used for different purposes. If you do mix them, you risk contaminating tax deductible money with money that isn't tax deductible which can lead to ultimately none of the money being considered tax deductible.

An offset account is one of the tools that helps you prevent this from happening.

Having your loan fully offset will reduce your outgoings to virtually nothing, but lenders will still assume the loan is fully drawn to the limit, the same way the assume credit cards are fully drawn to their limits. It doesn't affect your elibiibility for the next property.