All Topics / Help Needed! / I’m a bit confused

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  • Profile photo of KSJAKSJA
    Member
    @ksja
    Join Date: 2013
    Post Count: 5

    Hi all, I am a newbie and I am struggling to understand the concept of living off rental income by making interest-only payments.

    Say I own 2 IPs and I have to pay $1,400 mortgage per month for each IP and my rental income is also $1,400 per month for each IP. I understand if the values of the IPs go up, I can use the equity growth to put in deposit for another property, but still I have to continue to pay $1,400 per month assuming the interest rate stays the same and also assuming I continue to charge the tenant $1,400 per month rent.

    1) Am I right to say the amount of interest-only repayment are calculated based on the amount I owe the bank, so any equity growth will be irrelevant to repayment amount?

    2) In order to live off rental income, does it means that I have to wait till either the interest goes down or wait till I rise the rent?

    3) I thought interest-only mortgage comes with a 5 years term, is this when I start paying the principle on the 6th year then I will be able to start "living off" rental income because my interest repayment will go down as a result of reduced amount owing to the bank?

    Thanks for your patient and your reply will be very much appreciated,

    KSJA

    Profile photo of Richard TaylorRichard Taylor
    Participant
    @qlds007
    Join Date: 2003
    Post Count: 12,024

    Hi KSJA

    Firstly welcome to the forum and i hope you enjoy your time with us.

    Fear not no question is a silly question and this is what the forum is all about learning from others.

    Anyway here goes:

    1) Am I right to say the amount of interest-only repayment are calculated based on the amount I owe the bank, so any equity growth will be irrelevant to repayment amount?

     

    Yes that is exactly right. Your repayments will only increase on the basis you increase your borrowing. Leave it as it is and your repayments will be constant (subject to interest rates)

    2) In order to live off rental income, does it means that I have to wait till either the interest goes down or wait till I rise the rent?

    Yes i hate to say so.

    3) I thought interest-only mortgage comes with a 5 years term, is this when I start paying the principle on the 6th year then I will be able to start "living off" rental income because my interest repayment will go down as a result of reduced amount owing to the bank? 

    No you can extend your interest only period once the 5 years expires subject to your lenders criteria. Remember in Year 6 your repayments will increase not decrease as you are now starting to pay down the loan and the increased amount will be the principal reduction.

    Cheers

    Yours in Finance

    Richard Taylor | Mortgage Broker helping investors build their wealth thru property
    http://www.mortgagecapitalaustralia.com.au
    Email Me | Phone Me

    0-40 Properties in a decade with a unencumbered portfolio value in excess of $40M. Ask me for a copy of my API Interview.

    Profile photo of BennyBenny
    Moderator
    @benny
    Join Date: 2002
    Post Count: 1,416

    Hi KSJA,

      Good on you for putting it out there !!   There have been several posts recently discussing this "Interest Only" side of things.   Probably because our Mums and Dads (or grandparents) were brought up that you "Pay cash for most things, and pay off as quickly as you can those large-ticket items like houses!"   Sound familiar?

      So many of us were in the same boat – and the concept of paying Interest only goes against all we were taught by our elders.   It is a learning curve, but one you can learn to handle.  Let's look at your questions one at a time…..

    Quote:
    1) Am I right to say the amount of interest-only repayment are calculated based on the amount I owe the bank, so any equity growth will be irrelevant to repayment amount?

      Correct – Interest is calculated based on what you owe the bank.   Equity growth is your future gain (unrealised as yet – a paper gain if you will).

    Quote:
    2) In order to live off rental income, does it means that I have to wait till either the interest goes down or wait till I rise the rent?

      No, there is far more to it than that !!   First, many would say to buy something that is positive geared – i.e. it pays you MORE in rent than the cost to purchase.  If the rent you will receive is only equal to what the Bank charges in Interest, then your example is of a NEGATIVE geared property,  Mostly these rely on growth of Equity – but meantime, you have to fund it from wages.  

      So first, decide whether you want to purchased positive geared properties (so the rent received WILL cover the Interest, Rates, maintenance, insurance, etc – plus a bit extra for your pocket).  Then, when buying, look for a property that you can quickly "add value to" – it could need a clean up, or "look daggy" (worst house in a good street).  It could need a new stove, or a whole new kitchen.   You buy it cheaper because of this – so less loan to pay interest on – do the work, and rent at a higher rate.  You might also be prepared to sacrifice Income for Growth (buy a place with enough land to be sub-divided later).   The latter might be negative geared, but if that works for you, then go for it.

    Quote:
    3) I thought interest-only mortgage comes with a 5 years term, is this when I start paying the principle on the 6th year then I will be able to start "living off" rental income because my interest repayment will go down as a result of reduced amount owing to the bank?

      Many answers to this one. 

          a. Yes, IO loans are often only for 5 years.  But by then, you may well be in a position to completely re-structure your loans anyway, so you might take out new loans (with same lender, or another…)  

          b. Start paying principal in the 6th year?   Well, there are ways to do far better than that WITHOUT actually paying a cent off the Principal – have a read up on Offset Accounts – there are several current posts about these – Offsets are the bee's knees !!  cheeky

          c. The "living off rental income" likely won't begin for some years (depending on how quickly you amass a portfolio, and just how positively geared each one is).   But yes, you could quite soon be having your IP's paying you money, even if not enough to live on right away. 

      Here is someone else who was struggling a bit with Offsets and paying Interest Only – read their post (the first one) then some of the replies :-

    https://www.propertyinvesting.com/forums/help-needed/4349510#comment-296688

      It might engender more questions, but that is OK too.  The main thing is to get you thinking of a new way that works really well…..  

    Benny

    Profile photo of KSJAKSJA
    Member
    @ksja
    Join Date: 2013
    Post Count: 5

    Hi QLDs007 and Benny, thanks very much for your reply, your answers to my questions have made me come up with even more questions :)

    Before I move on, let me make the following assumptions for the example:-

    – I owe the bank $300k for each IP

    – The interest rates of the 2 mortgages are the same

    – I am able to put away $2,000 saving per month from my salary

    – A family of 4 needs $5,000 per month to live comfortably

    – The bank agrees to extend my interest only mortgage and I do not need to make payment to the principle

    Using the same example from my original post, I own 2 IPs and pay $1,400 interest only repayment per month and say I was able to add value to both IPs thus allowing me charge my tenants $1,800 per month for both properties. These recurring rental incomes will then go into the offset account for each property. Now I will be able to start paying less interest monthly because I have an additional $400 in each offset account plus my personal saving of $1,000 in each offset account.

    Here comes my question/comment:-

    1) To fully realize the $1,800 rental income, I need to have $300k in my offset account. I understand the flexibility feature of an offset account which I will be able to withdraw money to do things I like, but at the same time, once I draw money out, then I will have less rental income.

    2) To achieve $5,000 per month income to support a family as stated above in the assumption, I really need at least 3 IPs each with $300k in the offset account. Unless I win a lottery, to obtain that $900k, I really need to start off with much more IPs and then profit from the equity growth by selling them.

    3) I read the My four-year-old the property investor, it mentioned the equity growth from an IP can be used to fund the deposit of another IP. Can I ask the bank to turn the value of the equity growth into my offset account?

    4) Continue from (3), if I did use the equity growth to fund the deposit of another IP, wouldn't it create another loop where I have to find yet another $300k to allow me to realize the rental income?

    Thanks everyone and I wish you have a good long weekend.

    Kingsley

    Profile photo of BennyBenny
    Moderator
    @benny
    Join Date: 2002
    Post Count: 1,416

    Hi KSJA,

      I just saw this :-

    https://www.propertyinvesting.com/forums/help-needed/4349569#comment-297139

      Something like that could fill in the blanks re "How much was in Offset after 10 years, allowing for reduction in interest payments over that period."

    Benny

    Profile photo of CatalystCatalyst
    Participant
    @catalyst
    Join Date: 2008
    Post Count: 1,404

    It involves more than just sitting and waiting for rents to rise.

    Rather than repeat things that are in many places-  Type "Living off equity" into google.

    There is lots on it.

    Type this into google for lots of Living Off Equity dicussion threads.

    site:somersoft.com "LOE"                               Look for comments by Rixter. He's been doing it for years.

    Profile photo of KSJAKSJA
    Member
    @ksja
    Join Date: 2013
    Post Count: 5

    Thanks Benny and Catalyst for your replies.

    I was an average earner, I live in a share house and I own an investment property in Queensland. I was recently made redundant and I am planning to use the money the company paid me to do buy another investment property when I get a new job in place.

    I used two investment properties as example in my original post and in my subsequent replies because I want to determine how I would be able to achieve financial independence by owning two investment properties. Based on the information you have provided and the materials I have read through other forums, I guess I will have to spend the next 10 years building a large enough portfolio and will then be able to start realizing the benefit of property investment when the IPs grow in equities. So ideally, with at least 10 IPs in hand, I will then be able to use the increased equity from one IP each year to support my future family.

    Profile photo of Danielle.AllanDanielle.Allan
    Member
    @danielle.allan
    Join Date: 2010
    Post Count: 8

    One way to do what your planning is to have one property as a regluar buy and hold. The other you sell on Vendor Finance or Lease Option for positive cashflow. You pay all the positive cashflow into the buy and hold.

    As the LO/IC will go for 5 or so years you can expect to pay about 48k to 60k cashflow off the buy and hold plus the markup on the property of around 30k to 40k made up of deposit from the buyer and back end. This way you can build up equity quicker to buy the 3rd place that would be the second buy and hold.

    Combining the strategies and fiscal responsibility with the cashflow will give you a faster track to your goal.

    Danielle

    Profile photo of CatalystCatalyst
    Participant
    @catalyst
    Join Date: 2008
    Post Count: 1,404

    Hi, it needn't take 10 years, although that's a "typical" property cycle so that's what most people look at.

    You can  beef this up in different ways.

    The simple ones being buy and renovate. By doing this you can have increased equity and be CF neutral or positive from day 1. This allows you to buy again straight away. You can just keep buying because your LVR hasn't risen and your out of pocket expenses haven't risen either.

     We have done this recently.

    Another thing people do is buy new or near new and take advantage of the great depreciation, making your out of pocket expenses lower, thus enabling you to purchase again. The thing that slows people down is buying hugely negatively geared properties. You can only hold so many before the payments get to you.

    Or you can have a high paying job and pay down loans. I don't like this if it means forsaking purchasing. I'd rather purchase more, then you have more property to grow. Of course this is in the accumulation phase.

    It's a great time to buy while you can live in a shared house and your living expenses (I assume) are lower.

    Good luck with your journey.

    The thing is, with each purchase you want to make sure it gets you closer to your goal.

    We have interest only loans as we were in the accumulation phase. We are going to sell a few now to pay down debts and increase our cashflow as my hubby just retired and I'm following shortly.

    Profile photo of BennyBenny
    Moderator
    @benny
    Join Date: 2002
    Post Count: 1,416

    Hi KSJA,

       All good questions mate – the main thing missing is knowledge of the stages required.  In simple terms, the first stage is to build your portfolio, the second is to pay down debt (after some time), and the third is to live off the portfolio.    There are many questions just to do with the first stage. 

       But let me give you a "more likely scenario" to ruminate on :-

    In these early days, it is all about BUILDING your portfolio.  That takes many forms, and will involve building a team of advisers around you, purchasing the right property to suit your end goals, and growing your equity and income as you grow the portfolio.  The "Living off rent" bit comes later (think longer-term – like 10 years or so).  So, let's build a scenario around those two IP's of yours – you purchased them, got tenants in place, grew a team around you, and are looking to GROW your portfolio – HOW does that happen?

      Well, the good thing is that you seem to have some excess cash ($2k a month) that can help you with this.  All rent goes into Offset accounts, as does your wage (if you wish, you can even live on credit card for a month, then pull out enough to pay off your card once a month – your whole salary then helps to offset the monthly Interest paid, thus needing even less payment to the bank each month).   So rather than $400 a month extra helping you to pay less interest, you could be finding $8k a month doing the same job.  Howzat???  smiley

      Then, your Tax Returns allow you to claim any costs on a yearly basis, leading to a substantial refund cheque each year.  So the Taxman will help you to grow your portfolio too.   Those yearly refund cheques could also add a boost to your Offset account(s).

      And then, there is Equity growth – some manufactured by you, and some is created by the RE cycle.  Many say houses double in price every 7 – 10 years.   Let's say it does take ten years, then let's take a look at your situation after 10 years re those first two properties. 

      Even if you bought NO MORE IP's in that time, their values would have doubled, but your amount owing remains the same.  So, you are holding 2 x $700k properties (assuming they were worth $350k when you bought them).  But you only owe $300k on each.  If you simply sold them for $1.4m, after CGT, selling costs, paying the bank its $600k, etc you could likely walk away with around $400k – your "savings" over that 10 years if you like.  But wait, you have an Offset account with a chunk of change in it – close to half a mill (see below), so you have nearer $900k to do something with.   So that is $90k a year you have gained over those ten years – better than most wages.

      But then, WHAT IF YOU KEPT THEM??   After 10 years of "saving" in your Offset, let's take a look at a likely situation – let's see now:-

    1.  10 years of "an extra $400 a month in rent" x2 = $96k (that's assuming the rents NEVER went UP !!!)

    2.  10 years of "an extra $2k a month you can afford" = $240k

    3.  10 years of "Tax refund cheques" – let's say = $100k (not unrealistic, especially on your high rate of pay – it could be unrealistically LOW, depending on the properties).

    At this point, your savings in Offset have reached $436k – almost enough to pay off one-and-a-half loans completely.    You would at this point only be paying the Interest on $164k for two properties ($82k each).  

    OK, it was long-winded, and NOT complete.   Just the fact that the Interest paid goes down monthly means your Offset amount increases more each month to save even more Interest.     So, even if Rents didn't increase, the amount going out to the Bank would DECREASE each month.   It could be that you would have enough in Offset to pay them both off.  Thus, you have $1.4m in Equity in 10 years – or a gain of $140k per year !!!  Howzat???  

    Of course, rents WOULD usually be growing, and hopefully your wage too – so these are "worst case" figures. 

    Now work out just how much of that $140k came from you. 

    What if you did use equity gains to buy 3, 4, or 5 properties?   Yes, it would appear to slow your initial growth, but the final outcome would be even more impressive.

    I'll leave it at that (the audience sighs with relief….  cheeky) – consider just what can be achieved in a relatively short period of time by buckling down now.

    I'm glad the early answers led to more questions – that's how we learn…. and it shows you are eager for answers too.

    Benny

     

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