Quite simply I would like to know why interest only loans are better for property investors and how they work?
Cheers,
N
A common strategy for property investors is to have a mortgage over their principal place of residence and then seek additional finance for an investment property. As the investment property generates tax – assessable income, the interest on the loan used to purchase the property is tax – deductible.
As the PPOR does not produce income, the interest is not tax – deductible.
Therefore, the strategy is to maximise the tax – deductible interest charged, as this can be used to offset other tax – assessable income, whilst at the same time the PPOR mortgage is paid down as quickly as possible as this interest isn't tax – deductible.
If the investment property loan was a P&I loan (principal and interest repayments), over time the amount of interest charged would reduce and therefore lessen the tax deduction.
As for how they work, the major lenders usually offer interest – only credit for 3 – 5 years. After this time they may reassess the whole deal and ask you to begin paying P&I, however in practice they don't seem to care if the payments have been on time and the underlying security is sound and may offer another 3 – 5 years of interest – only.
IO is simpler than I&P.
how it works?
you would still have the choice of variable and fixed. and then you have the option to pay in advance or in arrears. last the option to pay weekly/ monthly/ yearly.
the rate slightly different, in advance would basically lower than in arrears. each and everyone has its own advantage and disadvantages for every investors with different financial situations.
one example of paying IO in advance for a year is the tax deduction benefit. you can pay 1 year of period 1 june 09 – 30 may 10 on the 1 june 09 and claim the tax return on the period of 2008/2009. in circumstances where in 2008/2009 you may generate higher income than the following year. and vice versa.
say you borrow $120K from bank with interest of 6%. calculating how much the repayment for I$P is hard. i would need to use the online calculator from one of the bank website.
on IO is basically:
yearly = 6% x 120K = $7200
monthly = $7200 / 12 = $6002ndly, on I&P every month on repayment you would have to pay Interest + Principal. on the same numbers above. IO per month is 600. IP per month could be 700. as for me (investor) I would like to pay as little as possible and that extra 100 would be better of invested elsewhere.
VERY INFORMATIVE ANSWERS HERE THANK YOU. WHAT HAPPENS TO THE PRINCIPLE IF YOU'RE ONLY PAYING INTEREST? AND HOW CAN YOU DRAW DOWN ON EQUITY IF YOU HAVN'T PAYED ANY PRINCIPLE. OR ARE YOU ONLY RELYING ON GROWTH TO DRAW DOWN FROM?
Tremelo wrote:VERY INFORMATIVE ANSWERS HERE THANK YOU. WHAT HAPPENS TO THE PRINCIPLE IF YOU'RE ONLY PAYING INTEREST? AND HOW CAN YOU DRAW DOWN ON EQUITY IF YOU HAVN'T PAYED ANY PRINCIPLE. OR ARE YOU ONLY RELYING ON GROWTH TO DRAW DOWN FROM?
Ok this should read,
Very informative answers here thank you. What happens to the principle if you are only paying interest? And how can you draw down on equity if havn't payed any principle. Or are you only relying on growth only to draw down equity from?
Cheers,
N
You would usually be paying down the principle on your PPOR loan first. Best to pay non deductible debt instead of deductible debt.
Even if you pay off your home loan it is still a good idea to use IO loans. The repayments are less, meaning you can afford more properties.
you can also use a IO loan with a 100% offset account attached so you can pay extra into the offset and save the same amount of interest as if paying PI and still have the cash available if needed.
Equity will build as values increase and your extra payments in the offset will be available too.
IO loans usually last 5 or 10 years max and then the loan reverts to PI. As time goes on rents increase so after this period the rent may be enough to cover the increased repayments.
Also consider, if you keep rolling the loan over to IO again that it may not matter too much if you ever pay the loan out. eg. imagine if you purchased a house in Sydney in 1960 and used a IO loan. The place may have been around $20,000 and if you still have a loan of $20,000 today it would be insignificant – you could probably pay it off with one years' rent.
Terryw | Structuring Lawyers Pty Ltd / Loan Structuring Pty Ltd
http://www.Structuring.com.au
Email MeLawyer, Mortgage Broker and Tax Advisor (Sydney based but advising Aust wide) http://www.Structuring.com.au
Terryw wrote:Also consider, if you keep rolling the loan over to IO again that it may not matter too much if you ever pay the loan out. eg. imagine if you purchased a house in Sydney in 1960 and used a IO loan. The place may have been around $20,000 and if you still have a loan of $20,000 today it would be insignificant – you could probably pay it off with one years' rent.That would be nice 20,000 for a Sydney property.
What if you intend only to rent and not have a PPOR type loan. Wouldn't that just free up more money for investing?
yep. I think IO for all loans is the way to go. You can always pay extra if you want to, but have the flexibility not to.
Terryw | Structuring Lawyers Pty Ltd / Loan Structuring Pty Ltd
http://www.Structuring.com.au
Email MeLawyer, Mortgage Broker and Tax Advisor (Sydney based but advising Aust wide) http://www.Structuring.com.au
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