Watch out for Principal on loans!

[Rosco]

When investors are looking at buying investment properties, most investors work on the interest costs. But what about the requirements from your bank to repay Principal?
For the first year or two, most banks will make an attractive offer to get a client on board. Often this includes offering an interest only period, which appeals to the investor as it helps with cashflow.
So a rental property might have $300 rent and cost $250,000. The investor might put in $50,000 cash, leaving a $200,000 mortgage. At a 5.79% interest rate, this property could be close to break even with no property management costs. So the monthly interest only cost would be $965 per month, but if this changed to Principal and Interest over 25 years, the P&I cost would increase to $1,263. This is an increase of $298 per month. Plus if interest rates increase to around the long term average of 7.5%, the P&I cost will jump up to $1,478 or an increase of $513 per month from the original interest only cost.
As an investor buying a new investment property, have you allowed for a possible increase of $513 per month for mortgage repayments? This could change your cashflow neutral investment property, into one requiring over $500 per month cash injection.
So when buying an investment property it is very important to consider Principal repayments and also a possible increase in interest rates

Ross

[Wayne]

Anyone have luck in getting IO really long term - like forever?

[Toasty]

Anyone have luck in getting IO really long term - like forever?

I have one coming off a 5 year rate in about a month. I have been offered interest only again up to 5 years so no problems yet. I don't think any bank will offer a permanent IO loan. They always restrict to a set term and then make you request it again so they can reappraise your situation.

[donna]

Yep - renewing is not a prob if LVR and debt servicing is good according to the lender. Some people prefer to pay off a chunk of the loan and then take up another IO over doing the P & I.

Cheers,

Donna

[TheLiberalLeft]

Don't you end up paying more interest in an IO loan over the full term than a regular table mort?

[Wayne]

well yes you would pay more interest but the theory is the capital value increases lots but the mortgage stays the same.

[TheLiberalLeft]

Why choose to pay more interest? If your theory is correct, you're implying it's a long term investment. So is it purely a short-term cashflow gain? It's certainly not a long term one.

[TheLiberalLeft]

In other words, given the capital gain is the same regardless of IO or table mort chosen, surely you're better off long term paying the smallest amount of interest? I've always wondered why people opt for IO loans given that they're paying way more over the period.

[Wayne]

affordability maybe. Can still pay down principle as money becomes available.

[NovInvestor]

buy at Year 0, don't increase loan on property during the interest only period (up to 10 years depending on bank).

At the end of the interest only period, ie 5 years or more, the market rent should have increased to cover the principal payments.

[Toasty]

I am accumulating the excess in an offset account so its effectively like paying the mortgage down in that the excess becomes slightly more each payment. This just means that when my wife finds the property she wants I can use the capital accumulated to pay for this rather than get a mortgage. Have unencumbered PPOR at the moment.

I would far rather just keep accumulating and stay where we are but what are ya going to do? I used accumulated a lot there....

[TheLiberalLeft]

I'm accumulating tiredness through boredom, toasty.

[DazRaz]

Why choose to pay more interest? If your theory is correct, you're implying it's a long term investment. So is it purely a short-term cashflow gain? It's certainly not a long term one.

Why not just pay cash for the property?

[TheLiberalLeft]

That's precisely what I'm doing at the moment, dazraz, but for mere mortals that's not always possible. So my question stands... if it's a long term investment, why pay 000's more in interest over that long term?

[Jumpin]

That's precisely what I'm doing at the moment, dazraz, but for mere mortals that's not always possible. So my question stands... if it's a long term investment, why pay 000's more in interest over that long term?

Long term it doesnt make much sense LL. If you have an aggressive purchasing plan, and choose to leverage every $ of equity, it can help to keep cashflow under control. Ultimately this is a high risk strategy, which takes out several unwary investors every cycle when LVR goes south, delayed maintenance and other unforseen expenses demand cash. Even if successful, this strategy is normally only used to jumpstart a portfolio aimed at generating rapid equity gain, and is modified to a less risky strategy as the investor reaches their property capacity.