Hey guys,
I'm having trouble working out the good part of having our IO loan (actually split, most IO, rest P&I).
Whilst on the phone to our lender today, I asked him if the interest we are paying on the IO loan is reducing the overall interest we will pay for the loan eventually. He said "No, it doesn't matter how much your repayments are, you won't pay less interest down the track just cos your paying high amounts now, they will be the same". I asked him if that means we are basically paying nearly 2k a month for nothing and he said yes! This is our first IP.
This seems crazy to me! We are not trying to free up cash for other investments or improve our cashflow because we still have to refinance down the track and give my mum back her equity. This is our main focus right now. Wouldn't we be better off with P&I therefor in an attempt to build equity and stop throwing our cash down the drain on IO payments?
I just can't seem to get my head around all this, so any knowledge is welcome
The advantage of IO is solely for cashflow purposes and on IPs to maintain the maximum leverage. If you have a redraw you can pay off as much as you like and this will reduce your interest payments and enable you to redraw the extra repayments at a later date should you require them.
As far as throwing cash down the drain, the interest repayments are holding costs that are offset by rental income and hopefully capital growth, so although you are not paying down your debt, you are (hopefully) increasing your equity with the value growth.
Thanks Rowdy.
The interest payments are only slightly offset by the rental income and although there has been some capital growth, I doubt it is significant. You mention 'redraw', we are just about to open an offset linked to the P&I (which is variable), but I still don't see the point in us paying huge interest payments when it seems like we should be trying to get our equity up.
Have we got the structure wrong if our aim is to build equity through repayments (due to Perth running out of steam recently)? It seems like the IO payments are sucking us dry.
Thanks for your thoughts.
Do you plan on purchasing a PPOR in future? If so I’d have an offset account, then later draw on it as a deposit for PPOR. You may have to post more details about what you are trying to achieve.
Hi Dee Dee,
Without going into the nitty gritty of % and figures.
Any extra money you want to pay should be put on the P&I part of your loan.
The IO part of your loan will stay the same amount unless you have an agreement that any extra you pay is taken off the pricncipal.
Are the loans fixed or variable?
An advantage of fixed IO is that you always know how much you have to pay back and if negotiated correctly can be cheaper than a PI. Thus easier to make a property cashflow positive due to lower repayment costs. A big downside of fixed IO is that when the fixed term is finished it becomes variable and if interests have gone up a few % then your positive cash flow may become negative cashflow unless you put some money down on the IO when the fixed term finishes. Some lenders allow you to pay a certain % or amount each year off an IO loan. Check with your lender again and have a look at your contract.C2
NOw that you have the offset account set up any extra cash would be best stored there as can be accessed without effecting the loan
Having IO means lower repayments. The extra you could have paid can now go into an offset account on your home loan. This will save you non-deductible interest. If you pay down an investment loan, you are reducing your tax deductions. It would be silly to do this while you still have a home loan which you cannot claim.
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
Thanks for the replies everyone
Yeah we would like to get a PPOR eventually, but not in the forseeable future because our rent is really cheap. My motivation for opening the offset is to use that money to pay down some principle on the current loan with the flexibility of being able to redraw should an emergency crop up.
I'm trying to get us in a position where we are building equity and I just don't see that happening with these massive IO payments. According to the lender we can pay back 10k per year on the IO loan before we start incuring fees (but I'm still not sure this would even be worth it). Here's the summary:Purchase price: 390k
Closing costs: 15k
Mum's equity: 20% (inc closing costs)
IP Currently worth: approx 415kLoan
350k IO (fixed for 3 years)
62k P&I (variable)
100% offset will be linked to P&IRental income:
$200/weekThe idea is we get this loan to a more managable amount (compared to the rental income) after refinancing and giving back the equity we owe (20%). Then buy another IP in about 4 years, possibly a PPOR after that, then more IPs for our self funded retirement, once IP income replaces work. We are 28.
If my thinking is not logical, I would definately like to know!
Thanks again
Yer it’s logical but you sound confused. Firstly, how much extra will you be able to save in next 3 years? Up to 62k? If so you are structuring it correctly. Don’t pay anything off the p&i component or variable component, just the minimum repayments. Rents will rise over next 3 yrs. Hypotheticly – Jan 2008 – $250/wk; Jan 2009 – $280/wk; Jan 2010 – $300/wk. Your property is now worth $500,000. The $100k growth in your property outweighs the interest over the past 3yrs. Your loan will start to feel less significant. after 3 years use 62k in offset account as deposit on PPOR. That way your maximising your tax deductable debt. Regards Linda
Hi Linda,
You're right, I have been quite confused about the concept of IO for a while. I was chatting with a mate about it tonight. She said that by paying IO payments each month I am keeping the debt the same, but if I was to pay more than the minimum it would reduce the interest payments. I think I have gotten to the point where I can't see the wood for the trees because I feel like it is so easy to realise why IO is of benefit, but it's like I've got a blindfold on!
What she was saying seemed to make some sense and I can also see what you are saying about rising rent & equity growth. I think I need to try and connect the dots now. If I still don't get it, then maybe the accountant can clear it up at tax time.
Thanks for your patience, have a great easter!
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