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  1. #1
    Join Date
    Feb 2004
    Location
    Welly-town
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    Default More on the P&I versus IO debate

    I've been doing a bit more analysis on the IO versus P&I approaches. Every deal I analyse givers far greater long term benefits from P&I (factoring in any annual profit / loss plus the equity gained by paying the mortgage down). This blew me away. I had heard so many "experts" saying IO was the way to go that I just assumed it was. I guess I'm the kind of person that needs to see it myself to believe it.

    The thing I am still weighing up is that using IO I could quite easily build up an income stream of $20k+ p.a. in the next year or so with the equity I have available. That's quite attractive. On the other hand, if I am prepared to sacrifice this short term income I could have a far greater one in 10 - 20 years time. Hmmmm, delemas!

    When doing the calculations on my own properties, I find I would have to commit money each year to meet the principle payments. Is anyone in the same situation? I guess after a while the snowball effect starts to happen and the profits from properties that you have owned for a while go into supporting the newer ones.

    If you haven't committed your own cash, and are planning to pay off the mortgage in less than the standard 25 year period, it suggests to me that you are getting some huge gross returns. Perhaps I haven't set my sights high enough!

    Comments appreciated.

    Thanks
    Gerrard

  2. #2

    Default Re: More on the P&I versus IO debate

    Quote Originally Posted by Gerrard
    The thing I am still weighing up is that using IO I could quite easily build up an income stream of $20k+ p.a. in the next year or so with the equity I have available. That's quite attractive. On the other hand, if I am prepared to sacrifice this short term income I could have a far greater one in 10 - 20 years time. Hmmmm, delemas!
    If you are trying to increase your investment portfolio I believe IO is the way to go, it gives you more spare cashflow. In your case you mention an income stream of $20k+. There is usually nothing to stop you paying this money off your IO loan each year.

    With a variable rate IO loan there should be no problem paying off principal, it's just that you don't have to. The choice is yours. It's also a whole lot easier to see how much is being paid in interest and how much is going to principal if you have an interest only loan.

    I believe the ultimate loan is a 25 - 30 year revolving credit loan but this type of loan requires a disciplined approach. I think of it like a loaded gun, it's a useful tool but can be dangerous in the wrong hands.

    Our strategy is to use interest only loans until we have a big enough portfolio and then start repaying loans.

  3. #3
    Join Date
    Dec 2003
    Location
    Hawkes Bay
    Posts
    1,732

    Default

    On the other hand, if I am prepared to sacrifice this short term income I could have a far greater one in 10 - 20 years time. Hmmmm, delemas!
    Hi Gerrard, there are two dilemmas or pains in life - the pain of discipline which is short term, and the pain of regret which is long term.
    It really is a decision you will need to make. Personally, you know what my answer would be. I want the tenants to buy the property, that is pay it off for me. If I have to pay for it, or wait for it to possibly go up in value one day, some day - then I don't want it. Also, if I get $1,000 or so cash from it a year, that is not something I would be happy with long term. I would not be prepared to wait for how long ever it would take, for it to be worth a far greater amount than what the market value was, when I bought it. Who knows, in 10 years time, properties may even be worth less than what the market would pay for them today. I am not prepared to take that chance, even if it is a slim chance. I don't gamble and to me even though the risk may be slight, I wouldn't take the bet and put everything I own on the line for a guess of what will happen in the future.
    But my main point again is that an investment is something that someone else pays you to own.

    When doing the calculations on my own properties, I find I would have to commit money each year to meet the principle payments.
    You just need to increase your deposit slightly to make up for it.

    If you haven't committed your own cash, and are planning to pay off the mortgage in less than the standard 25 year period, it suggests to me that you are getting some huge gross returns. Perhaps I haven't set my sights high enough!
    Most mortgages are either 20yrs, a very few are 25, some are 15 and some are 12. I think 20 yrs is a good figure to go with when starting out.

    Regards
    Graeme Fowler

  4. #4
    Join Date
    Feb 2004
    Location
    Welly-town
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    Default

    Our strategy is to use interest only loans until we have a big enough portfolio and then start repaying loans.
    I was thinking down that track myself for a while. However what would I do with that additional cashflow now? I'm pretty disciplined with money so could use it to pay off my own home. However it would be quite easy to just go into the pot and end up being spent on that Fiji holiday, or updated car, or nicer couch.

    Instead of taking that risk I'm now thinking leave the cashflow in the properties to pay off the mortgage. This is where the real benefits come from. After all you don't take the interest on a bank deposit (or dividend on a share) out at the end of the year. You let it compound and you get the exponential benefit rather then just linear.

    You just need to increase your deposit slightly to make up for it.
    I have been borrowing 100% using equity from my own home, so haven't been putting in "real cash". By raising my criteria of what to purchase, I can make this work without putting in any cash.

    Gerrard

  5. #5
    Join Date
    Jun 2005
    Location
    Auckland
    Posts
    5,086

    Default

    Quote Originally Posted by orion
    When doing the calculations on my own properties, I find I would have to commit money each year to meet the principle payments.
    You just need to increase your deposit slightly to make up for it.
    How far do you take this - if you have to put in sufficient deposit to make sure that the repayments cover the rent, then don't you run the risk of negative gearing?

    cube

  6. #6
    Join Date
    Jan 2004
    Location
    Whangarei
    Posts
    5,867

    Default

    However what would I do with that additional cashflow now?
    I'm on IO and have some extra cashflow. I'm using it to tidy up the properties, redecorate and paint the roof. Don't let yourself get into the situation where you have no spare cashflow to help you out when something goes wrong.

  7. #7

    Default

    Quote Originally Posted by Gerrard
    [However what would I do with that additional cashflow now? I'm pretty disciplined with money so could use it to pay off my own home. However it would be quite easy to just go into the pot and end up being spent on that Fiji holiday, or updated car, or nicer couch.
    You can use it to pay off some of your loan. Just because it's interest only doesn't mean you can't pay off principal. I view 30 year loans the same way, just because it's 30 years doesn't mean I can't pay it off quicker.

    Having interest only and a long loan term just gives you flexibility and revolving credit is the ultimate in flexibility, if you have spare money put it in the loan. If you need it back, take it back out again. The more spare money you park in your revolving credit the greater your protection if something bad happens.

  8. #8
    Join Date
    Dec 2003
    Location
    Hawkes Bay
    Posts
    1,732

    Default

    How far do you take this - if you have to put in sufficient deposit to make sure that the repayments cover the rent, then don't you run the risk of negative gearing?
    Hi Cube, when people say 'negative gearing', they often are meaning very different things, and therefore it depends on the individual's perception and interpretation of what it means to them.
    To me, I view it as the rent covering the mortgage, rates & insurance + say a couple of thousand dollars per annum for maintenance. I don't take into account depreciation. To get this in most areas nowadays, you will need to put in a deposit so that these costs are all covered (so the mortgage payments are reduced), unless you buy in low priced areas, or locations that most people do not want to live.
    There is a point though where it is not worth doing, no matter what the deposit you put in. To speak in terms of 'yield', anything below about 6 -7%p.a. to me would not be worth buying. Example a $200,000 property would have to rent at $14,000 p.a. or $270 p.w. This means the property will return 7% p.a. of the property's price by way of rent, if it were freehold. Now, if that same property was worth $400,000 and still could only manage the same amount of rent, it would require a far greater deposit to make it 'neutral or slightly positively geared' therefore making it not feasible.
    Many investors in Sydney for example are still buying properties with 1- 2% 'yield' on interest only which to me is just outright insane. Either they are highly negatively geared, or are putting a huge amount of their own cash as a deposit (or other equity which will only go so far, thereby limiting future purchases), so all outgoings are covered. There are relying solely on capital gain, nothing else.

    Regards
    Graeme Fowler

  9. #9
    Join Date
    Aug 2003
    Location
    auckland
    Posts
    413

    Default

    Hi

    I have been reading this thread with interest. We have been purchasing our properties under a P&I and revolving credit structure. I guess that we like the idea that we likily live in a tax free environment and are earning good money.

    As we live as expats we do purchase with 20% deposit and do try and purcase at the 7% return level. It might take us a bit longer to get to our end result but we feel very happy with the fact that we can pay off Principal as well as interest and will feel long term benefit from this, we will be able to put spare money into our property and draw it out when necessary and have security in knowing that we have buffer money also ready to draw up should it required. We do this by reinvesting any income into the mortgages.

    Along with all of this we are still able to save and purchase again with 20% deposit.

    Perhaps if we were residing in NZ and purchasing we might structure things a little differently.

    Tamara

  10. #10
    Join Date
    Dec 2003
    Location
    Hawkes Bay
    Posts
    1,732

    Default

    Well done Tamara, sounds like you are doing really well!

    Regards
    Graeme Fowler


 

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