P&I vs IO. Which way is best

[Frezzinghot]

Question:

I have 375k coming off a fixed term at the end of this year, the current rate is 4.99 from a fixed loan we took out 4 years ago. The loan is currently on P&I payments and I'm wondering if we should look to go to IO.
We still have private debt on our PPOR but its good to see the rental property debt reducing also at the same time. Our work situations have not been affected by the cover 19 crisis and all our payments are being made
as usual. New interest rates are low so some good savings to be gained at the end of the year. Here are some of the options available to me.

1. Stay on P&I, fix for a year at 3.09(current tsb rate) use surplus to pay down a RC account with some debt on it.
2. Change loan to IO for a year at 3.09 and use surplus to pay down PPOR debt, reducing loan term.
3. Float the loan in December on P&I and wait to see where rates go, leave surplus in RC account or pay off more PPOR debt.
4. Fix loan on IO, use surplus to buy peoples toys they are forced to sell amongst cover 19 & have a good time! (no where to go, sigh!)

Lot to ponder but questions remain, how low will rates go, is this the time to be paying off debt or save for rainy days ahead. Will the banks even let us go on IO? We are cashflow +ve atm so no pressure their either and we are looking to buy another in about 6 months time.

FH

[Keys]

IO on IP.

Savings of payments go to the OO

[Don't believe the Hype]

IO on IP.

Savings of payments go to the OO

what keys said



Rates might go lower but there is more upside risk that downside opportunity.
Leverage the coming off fixed to borrow as much money as you think you'll need for any buying you want to do over the next 12-24 months based on what banks will allow with their own LVR and servicing requirements then keep that cash in offset

The trick will be getting the timing right (as always) - while waiting might get you a slightly better rate if banks go to conservative of their own accord OR valuations start to go down driven by cautious valuers you might not get the sweet spot of good rate and good (safe) leverage.

[Frezzinghot]

what keys said



Rates might go lower but there is more upside risk that downside opportunity.
Leverage the coming off fixed to borrow as much money as you think you'll need for any buying you want to do over the next 12-24 months based on what banks will allow with their own LVR and servicing requirements then keep that cash in offset

The trick will be getting the timing right (as always) - while waiting might get you a slightly better rate if banks go to conservative of their own accord OR valuations start to go down driven by cautious valuers you might not get the sweet spot of good rate and good (safe) leverage.

So theoretically we have just increased our income then, I have not done the calculations yet but we could be bringing in an extra 18-20k per annum so in the banks eyes we have increased our income. But if we put that increase into the OO loan don't we effectively loose the increase in the banks eyes?

[Nick G]

Pay your own home off first. I'd change it to IO this instant.

To pay a dollar of interest on your home you earn $1.30, pay .30c in tax, pay the dollar. After tax cost to you $1.30
To pay a dollar of interest on a rental you pay $1, claim back .30c. After tax cost to you .70c

The above is not accurate maths of course but it is the example I use when explaining the concept. You are paying nearly double when you pay interest on your house.

You probably want to automate the financial discipline to make the same overall payments, so you could increase payments on your OO to match.

[I am not a financial advisor and this depends on tax rate and you getting a calculator out to check the numbers yourself]

[Jeffa]

Any of your investment properties should be on interest only, use the extra income to purchase more, TSB are uptight with interest only get a mortgage broker that can find a bank to have the rental property/s on interest only for atleast 6 years or more, paying down debt is a waste of time (like working for a wage)
Your assets will increase much faster than you can pay down debt in the next 5 years.
If you have any personal debt get that cleared with topping up and be disciplined don't accumulate any more bad debt if you want to retire in the next 10 years. (You don't need to impress the Jones,Wealthy people don't flaunt their wealth only wannabes do)
Interest rates will be %2.55 in December.
Don't worry about them increasing for atleast 4 years.
Increase your rents annually-extra income
Your interest rates will decrease -extra income
Your assets will appreciate-increased net worth.

The last sentence is the most important, its not how much you make in income, its your net worth that decides your future.
It opens doors.

Look at all the businesses failing, many would have been making millions.

[donna]

On Matthew (GRA)'s video conference the other night he said go IO on IPs as debt is basically free. If you were on P&I on 500K - going IO saves you $30K so use that to pay down your PPOR debt. And that interest rates will be low for years. Great time to buy IP.

cheers,

Donna

[Anthonyacat]

To pay a dollar of interest on your home you earn $1.30, pay .30c in tax, pay the dollar. After tax cost to you $1.30
To pay a dollar of interest on a rental you pay $1, claim back .30c. After tax cost to you .70c

The above is not accurate maths of course but it is the example I use when explaining the concept. You are paying nearly double when you pay interest on your house.

Sorry Nick, just got to fix this. It's no where near double. You have to compare after tax with after tax, or before tax with before tax. $1 vs $0.70, or $1.30 vs $1. Can't compare $1.30 with $0.70!

However, it doesn't need to be anywhere near double to make a massive difference over time.


If you have a $500k private mortgage and a $500k rental mortgage, each on P&I over 30 years at 4%, your payments are $2,387 per month on each loan, $4,774 combined. Total payments over 30 years $859,347 per loan (so paying $359,347 in interest, each). Both mortgages are paid off after 360 months (30 years). Total payments are just over $1.7M, of which $359k is deductible rental interest, reducing your tax by $118.5k.

If you switch your rental mortgage to interest only (and hypothetically keeping it there for many many years), your rental interest-only payments drop to $1,667. Shift the extra $720 principal to your PPOR and it's $3,107 paid each month. Your PPOR loan is paid off in 230 months (more than 10 years early) and then you put the full $4,774 against the rental, that will take just over 10 years to pay off. Both mortgages are paid off after 360 months (30 years). Total payments are the same at just over $1.7M, but this time $501k is deductible rental interest, reducing your tax by $167k; saves you almost $50k extra without costing you anything at all.

Taking it a step further (at which point my math is a bit more rough) if you plowed just the additional $50k of tax savings back into the mortgages once a year ($44 at the end of year 1, $163 year 2, $287 year 3... $1,309 year 10... etc) it cuts a full 18 months off the total mortgage payoff date, and saving a further $30k of interest!

[Don't believe the Hype]

So theoretically we have just increased our income then, I have not done the calculations yet but we could be bringing in an extra 18-20k per annum so in the banks eyes we have increased our income. But if we put that increase into the OO loan don't we effectively loose the increase in the banks eyes?

Well strictly speaking your income has not changed, you've had a reduction in expenses resulting in a higher profit (or smaller loss) - this is what the bank will be interested. What you spend that saving on is not really of interest to the bank. But if you tell them you're going to pay down debt they'll think you're a good operator... and having your banker/bank think you're a good operator you might get more support for more borrowings when things are tight.

[Frezzinghot]

IO on IP.

Savings of payments go to the OO

Thanks for explaining.

[Frezzinghot]

what keys said



Rates might go lower but there is more upside risk that downside opportunity.
Leverage the coming off fixed to borrow as much money as you think you'll need for any buying you want to do over the next 12-24 months based on what banks will allow with their own LVR and servicing requirements then keep that cash in offset

The trick will be getting the timing right (as always) - while waiting might get you a slightly better rate if banks go to conservative of their own accord OR valuations start to go down driven by cautious valuers you might not get the sweet spot of good rate and good (safe) leverage.

Makes sense and exactly what I'm about to do.

[Frezzinghot]

Any of your investment properties should be on interest only, use the extra income to purchase more, TSB are uptight with interest only get a mortgage broker that can find a bank to have the rental property/s on interest only for atleast 6 years or more, paying down debt is a waste of time (like working for a wage)
Your assets will increase much faster than you can pay down debt in the next 5 years.
If you have any personal debt get that cleared with topping up and be disciplined don't accumulate any more bad debt if you want to retire in the next 10 years. (You don't need to impress the Jones,Wealthy people don't flaunt their wealth only wannabes do)
Interest rates will be %2.55 in December.
Don't worry about them increasing for atleast 4 years.
Increase your rents annually-extra income
Your interest rates will decrease -extra income
Your assets will appreciate-increased net worth.

The last sentence is the most important, its not how much you make in income, its your net worth that decides your future.
It opens doors.

Look at all the businesses failing, many would have been making millions.

Thanks for explaining, the above quote add some clarity around my plan to retire in the next 10 years, I think I will print this out and pin it to my office to remind me of what needs doing over the next 5 years as I transition from employer to self employed. You just don't know what you don't know!

[Frezzinghot]

Sorry Nick, just got to fix this. It's no where near double. You have to compare after tax with after tax, or before tax with before tax. $1 vs $0.70, or $1.30 vs $1. Can't compare $1.30 with $0.70!

However, it doesn't need to be anywhere near double to make a massive difference over time.


If you have a $500k private mortgage and a $500k rental mortgage, each on P&I over 30 years at 4%, your payments are $2,387 per month on each loan, $4,774 combined. Total payments over 30 years $859,347 per loan (so paying $359,347 in interest, each). Both mortgages are paid off after 360 months (30 years). Total payments are just over $1.7M, of which $359k is deductible rental interest, reducing your tax by $118.5k.

If you switch your rental mortgage to interest only (and hypothetically keeping it there for many many years), your rental interest-only payments drop to $1,667. Shift the extra $720 principal to your PPOR and it's $3,107 paid each month. Your PPOR loan is paid off in 230 months (more than 10 years early) and then you put the full $4,774 against the rental, that will take just over 10 years to pay off. Both mortgages are paid off after 360 months (30 years). Total payments are the same at just over $1.7M, but this time $501k is deductible rental interest, reducing your tax by $167k; saves you almost $50k extra without costing you anything at all.

Taking it a step further (at which point my math is a bit more rough) if you plowed just the additional $50k of tax savings back into the mortgages once a year ($44 at the end of year 1, $163 year 2, $287 year 3... $1,309 year 10... etc) it cuts a full 18 months off the total mortgage payoff date, and saving a further $30k of interest!

Hi Anthony

Thanks for the detailed explanation, its a lot to take in, my accountant did advice to go IO as well, but I was getting good cashflow and thought it was the way to go, obviously not!

[Frezzinghot]

On Matthew (GRA)'s video conference the other night he said go IO on IPs as debt is basically free. If you were on P&I on 500K - going IO saves you $30K so use that to pay down your PPOR debt. And that interest rates will be low for years. Great time to buy IP.

cheers,

Donna

Yes I watched that last night as well, Tony Alexander did seem a little over optimistic though and without a crystal ball we are going to find out, probably in about 6 months?

[propertynewb]

This is the most valuable thread I have read on here - thanks. Light bulb moment.