Interest Only Loans Are Expiring and What to Do Next?

easoweno on 23/02/2018 - 16:38
Last edited 26/02/2018 - 14:44

A brief about our financial situation.

We have 4 loans, home loan is $1.3 mil with offset account (80% LVR), and the other 3 investment properties is also $1.3 combined (80%LVR for 2 and 90% LVR for 1). All properties are IO at the moment and they are due to expire around June/July and will back to P+I. All 3 investment properties are slightly positive WITHOUT paying principle for the investment properties (let’s say $1000 all up). Since IO is expiring soon, we spoke to a broker the other day to get advice to see whether we can move everything to somewhere else and continue to pay IO for investments and P+I for home loan.

He said we can move but wife has to work full time otherwise we are $18k short from our combined income, or to cover that, we have to put $120k into the loan to cover the shortfall. Here are my questions:

  1. He said even you need to pay a higher rate for IO, you should still do it because A. it affects your cash flow (agreed totally), B. it’s really not that much difference because it’s tax decuctible. C. your goal for investments is not to pay it off, but to keep it alive and cash in when you can make a decent profit when you retire or whenever you need to, etc, etc. Is it a bad thing to pay off your investments? Apart from the tax part? My motto so far is that we should not pay more money for the sake of getting tax deduction or am I wrong? I know I am paying more for P+I but in the end it’s money going towards the house, not interest that’s gone in the air.

  2. Worst case scenario, we have to pay P + I for all properties, we will be going backwards by about $1-1.5k a month, with what we have in our savings account, we should probably be ok to support it for at least 5 years while maintaining our lifestyles, however it’s not a nice feeling, do you think it’s realistic to think the policy would loosen up more later on and we maybe able to borrow the full amount without my wife working full time (full time is just not a option at the moment)

EDIT: Thanks for the property boom we have approx. $800k in equity for all IPs combined if we want to sell now in today's market.

Financial

Comments

  • dcep on 23/02/2018 - 16:43
    +3

    "do you think it’s realistic to think the policy would loosen up more later on"

    no

    7 trillion housing market and rising

    debt still going up

    • easoweno on 23/02/2018 - 16:46

      I dont know…. I got all these loans 3 years back and it was easy back then… a year ago I asked the same broker, he told me don't even think about moving, but now he said there's room to move. so I am guessing would it keep loosen up since the property market has cooled down quite a bit

  • [Deactivated] on 23/02/2018 - 16:55
    +1

    Sell the houses
    Live on the streets

    • whooah1979 on 23/02/2018 - 21:08
      +2

      That would make sense if op were a troll and could live happy under bridge.

  • tryagain on 23/02/2018 - 16:58
    +2

    we should probably be ok to support it for at least 5 years while maintaining our lifestyles, however it’s not a nice feeling

    Just think of it as effectively moving your savings out of a bank account and into bricks and mortar. The interest payments you get nothing to show for, but if you are paying principal you have more equity to show for it. Given your exposure, I am assuming if the property market falters/interest rates rise considerably, you are likely to be screwed whether you have cash in the bank or less debt on the houses.

    • easoweno on 23/02/2018 - 17:01

      that is my worry too… I got a spread sheet with all sorts of interest rate numbers, if it goes up by 0.75% then we def will have to sell, but now I think we can still hold… you reckon selling is better option?

      • tryagain on 23/02/2018 - 17:13
        +4

        Without knowing all your details like income, current house values, where they are located and a number of other factors, its impossible to say, even if I did know them I am not a financial planner, I'd be having a chat to someone who is. Exposure can work both ways though if values increase, the more exposure you have the better, if they don't then the opposite is true, and nobody knows for sure what it is going to do. Also, keep in mind when interest rates go up (it's not a matter of if but how much) there will be others in the similar situation in needing to sell and then supply and demand will do its thing as well.

        The underlining question is probably what is your appetite for risk.

      • mskeggs on 23/02/2018 - 17:30
        +9

        Wow.
        My eye is twitching with anxiety just reading this.
        As you know, prices will dip if rates rise. How do you sleep at night?

      • Woodinski on 23/02/2018 - 18:46
        +2

        It is not a matter of if it goes up, but when it goes up. Your situation is seriously worrying.
        I assume that if you lost your job for a reasonable period of time it would be all done and dusted too?

        • easoweno on 23/02/2018 - 21:57

          I have insurances in place, and IMAO, everyone's screwed if you ever lost your job, no matter if you have nil or a lot of investments….

        • Quantumcat on 24/02/2018 - 11:03

          @easoweno: if you have no investments and no debt you can just move into a cheaper place like a sharehouse or back with your parents, in the event of losing your job. Having investments makes your life very risky

      • Wonka on 24/02/2018 - 11:28
        +5

        You only have a margin for 0.75% of an interest rate rise? As in less than 1% increase is the difference between you holding the properties or selling?

        Call me risk adverse but this level of exposure seems insane.

        If your on a knife edge with a 1% rate increase and you have to sell under distress - Do you have enough equity in the house if it was to devalue significantly by the time you go to sell?

        • easoweno on 26/02/2018 - 14:23

          one IP has 40%, one has 50% and one has 23% in equity, I hope this is ok to cover some level of devaluation. Plus where do you get 0.75% from?

  • ohsotight on 23/02/2018 - 17:01

    Wont your existing bank let you renew the interest only loans again for another term?

    • easoweno on 23/02/2018 - 17:02

      current IO is $3.99% but I think it will jump to 4.7% if we wanna stay IO

      • Meho2026 on 23/02/2018 - 18:22
        +4

        If you can afford it, my recommendation would be to extend the IO loans on the investment properties even if it is at a higher interest rate and let the PPRloan roll over into P&I.

        It will cost money to refinance elsewhere and I doubt you'd get an interest rate lower than 4.7% that would justify the expense of changing lenders, never mind the hassle involved.

        You don't mention if you have any cash in your offset account.
        If you don't I can't see how your figures stack up.

        Apologies in advance if I've made any arithmetic errors.

        Your current annual positive cashflow on the investment properties is $12000, assuming you're in 37% tax rate. You' currently pay $4400/year tax on that income.

        An increase of 0.71% in the interest rate to 4.7% will reduce your positive cashflow on the investment properties by $9230 a year to $2770. Therefore you'll pay tax of $1025 a year. It means you're reducing your tax bill by $3375 a year while still having a positive cashflow investment wise.

        Although your cashflow has dropped $6460 if you subtract the reduced tax payable of $3375. Your down $3085 a year net.

        If you've been using the investment property cashflow to finance your PPR loan ithen that's a big deal.

        Changing your PPR to P&I with 27 years left on your loan at 3.99% is going to take your payments from $4300 on IO to bout $6500.

        That's huge an extra $2200 a month. Plus if you have been using investment cashflow to fund that loan your down an additional $257/month ($3085/12).

        The only variable I can think of is if you have cash in your offset account. You say you'll be out 1K-1.5K a month, say it's $1250, that's $1000 month less than my calculations. Does that mean you have $300,000 in your offset?

        Cos if you do I reckon you should pay for qualified financial advice.

        You can't pull cash out the investment properties cos u don't have enough equity and even if you did the interest on anything your drew out wouldn't be tax deductible.

        If you've got extra income do it on the basis of reducing your non deductible debt i.e. Your PPR loan.

        If not it looks like you might have to downsize or sell an investment property.

        • easoweno on 23/02/2018 - 22:09

          Thanks for your detailed reply. We do have money in our offset account, not huge but decent to cover ourselves for a while. When I said I am going backwards by $1-1.5k per month, I meant the money eating in my savings after I pay P+I for all properties and living expenses.

          And thank you for laying it all out with all the numbers with tax implications, I think that's what I needed to figure out about how much worse I will be with higher interest rate while having negative gearing.

          I actually called one of the banks this afternoon after this post and they told me if it expires now, I can get another 2 years IO at 4.19% for one of the IP and it can be done over the phone, so I think somehow it will work out in the end.

  • ohsotight on 23/02/2018 - 17:11
    +1

    Generally with an IP you dont want to pay down the loan much as you want to get 100% dedctibibilty.

    However if the rate difference between P&I and Int only is significant and you can afford the principal component what you can do is go to P&I for a few years and probably assess if the int. only market changes during that period and you can get back on it. Unlikey that APRA will change their views but banks could be chasing more IP loans by then. Who knows.

    In two years you wouldnt pay more than 35k in principal for a 1M loan hence you arent losing much in terms of deductibilty either.

  • Cartman2530 on 23/02/2018 - 17:16
    +7

    I have a feeling many people will come into hardship later on as their IO loans expire and they are stretched too thin and cannot service a P+I loan or do not meet the tighter lending criteria to get another loan.

    At least you are thinking about your future and you have the option of your wife working, which would be the smartest idea in this situation if you want to continue with things the way they are. Eating up your savings wouldn't be a great idea.

    I don't think the policy will loosen up, with the bank royal commission proceeding, they might tighten up even more depending on the findings.

  • jug123 on 23/02/2018 - 18:25

    Ive had IO investment loans for well over 10yrs, just get the bank to roll it over. Youve got enough in equity & theyll like the amount your paying them monthly & that youre a reasonably safe bet, they wont want to lose your money

    • mskeggs on 23/02/2018 - 22:12
      +3

      The issue is that:
      A) APRA has told the lenders to charge more for IO loans, because people were buying multiple investment properties with insufficient cashflow and equity to the point where a trifling 1% interest rate hike would be a big problem.
      B) Interest rates in the US and other parts of the world are rising, so when our local lenders approach the global market for funding they will need to pay higher rates, forcing them to raise local rates.

      SO it will be hard for somebody like the OP to find competitively priced IO loans now (compared to the all time low rates have been until now), and likely harder still in a year or so time.

      • jhmtaylor on 24/02/2018 - 14:08
        +2

        The chairman of the US Federal Reserve is on the record saying they are targeting 4 interest rate rises during 2018. The reserve banks in Europe and Japan are also keen to increase their interest rate (some are below zero)so Australia will follow suit because we borrow heavily from overseas.
        Allowing for bank margins on top an additional 1.15% is forseeable with the next 10 months.

      • jug123 on 02/03/2018 - 18:17
        +1

        A)APRA has only instructed the banks to reduce new IO lending to 30% of all new lending, then banks are doing the increases on their own as way to stem the flow.
        B) this has nothing to do with being asked to move from IO to P&I

        OP hasnt mentioned rates, he's talking about having to move to P&I. IO investment rates are now already 1% higher

  • craigd on 23/02/2018 - 18:31
    +4

    I've never understood negative gearing as a long term strategy. The concept is very short sighted. Pay P& I if you can afford it or offload one of the properties. The principle you are paying is a form of savings

    • mskeggs on 23/02/2018 - 18:58
      +4

      The idea is to buy more properties than you can ever afford to pay off, carry the loans as IO, then sell half of them when they have doubled in value. Use the proceeds to pay down the remaining ones.

      Works a treat as long as property prices keep doubling and interest rates stay impossibly low.

      • Wonka on 24/02/2018 - 11:32
        +2

        if

  • chumlee on 23/02/2018 - 18:39
    +6

    Your strategy works in todays market so my only advice is watch out.

    Trump government cannot rack up trillions in debt as well as running massive budget deficits, tax cuts and huge infrastructure spending.

    Interest rates will soon rise and they will be fast rises

  • KaTst3R on 23/02/2018 - 20:08
    +3

    I can see why house prices have gone up so much over the past 5 years. Some people have gone nuts over their loans and any change in financial situation or rise in interest rate could potentially blow them up.

  • JimmyF on 23/02/2018 - 20:17
    +1

    So OP, you have talked to the bank/broker and still come here for advice?

    Do you think there is some magical answer they didn't tell you about?

  • conan2000 on 23/02/2018 - 21:23
    +1

    I have a PPR loan and investment loans, and I'd say where you can afford it, pay P&I on as many loans as possible to minimise risk. You can always flip some to IO if you need better cash flow at any point in time. E.g. We may do when we are on single incomes (maternity leave etc).

    All of my loans are P&I at the moment and paying down about $300p/m of investment debt and about $1500p/m on the PPR. I'm not investing purely for tax benefit, and unless both my partner and I hit the highest tax bracket, never will invest purely for this purpose. I want the investments to be extra income when I'm older/retired, so don't really want to risk dips in the property market meaning I have negative equity in investments.

  • JIMB0 on 23/02/2018 - 21:59
    +6

    I'd say it's time to panic.

  • monkeybusiness on 24/02/2018 - 00:14
    +2

    You are geared to the max. Have you considered potentially selling one of the investment properties to pay down debt and be in a better position financially? While some debt is good, overdoing it introduces a lot of risks. You also don't have much room to maneuver if situation changes. You are also making assumptions that lifestyles don't change. Are kids going to be in the picture at some stage?

    Paying down debt is probably one of the smartest things you can do right now with low interest rates. Don't expect house prices to rise rapidly so you better be prepared to position yourself financially in case of changes in circumstances.

  • dp1 on 24/02/2018 - 11:15
    +2

    I also don't get how you sleep at night. What's your exit strategy? As in, if you can't finance your existing loans how will the people you want to eventually sell to?

    There is talk about about the coming 'p+i cliff' as increasing numbers of investors all head for the exits together when i/o loans roll over to p+i and the numbers don't stack up

  • Steptoe on 24/02/2018 - 11:31
    +2

    You don’t mention how much equity (positive or negative) you have in each of the 4 properties.

    You don’t mention the potential to rent out your PPOR ever, but something to consider long term.

    If in this situation I would keep all IO loans and put all spare $ into PPOR offset account.

    The 90% loan might need to come down to 80% to avoid LMI again. If you can’t manage that, maybe you need to consider letting it roll into P&I after crunching the numbers.

  • born2reign on 24/02/2018 - 13:56
    +3

    Nothing wrong with paying P&I, the days of IO forever is slowly but surely being phased out.

    I'd only try to hang onto IO loans if you're striving to save up a deposit for an additional property. If you've already completed your property portfolio then you are no longer in the "accumulation phase" and you're in the "debt reduction phase" and you may want your PPOR and one of your IP to roll onto P&I loans while keeping 2 on IO loans maybe?

    Definitely do not extend IO periods in the same month again, stagger them out so you have 6-18 months between each of them coming off the IO terms or you're going to have the same financial stress in a few years time again when they the IO term is about to finish (you're not getting any younger so I doubt you will get IO extended again after this time, in fact it's debatable whether you'll get IO extended again now under the current credit environment unless you refinance away to a non-APRA governed lender and be slogged with an even higher interest rate for the privilege of IO

    I'm in a fairly similar position to you, except I rent for $480 a week instead of owning a PPOR, I'm currently in the process of saving a deposit for a 4th I.P (in Brisbane) and my IO periods don't end until 2020 / 2021, so I completely understand where you're coming from.

    Don't forget that your rents will go up over time and that will help somewhat.

    Also don't forget that it's highly likely that interest rates will go up twice within the next 24 months or so and that is going to sting you almost as much all of your loans coming off their IO period at the same time, so you need to prepare for this scenario as well. For example your 2.6 mil debt @ 4.5% interest is about $9,750 in interest payments a month (half deductible, half non-deductible) and if there is just one lot of interest rate rises (usually comes in pairs) and your rates at at 5% then your new monthly (interest, not principal) are closer to $10,850,

    So that's an extra $1100 per month out of your pocket quite quickly which is a comparable sting to 2 loans coming off their IO periods and reverting to P&I.

    Nothing wrong with with paying out your investment loans, forget the tax benefits - they are useful for the first few years while your holding/interest costs are at their highest and rent at its lowest but we don't invest to get a 50c rebate for every dollar we spend in holding costs. Paying tax on positive earnings is a far superior financial position than getting a partial tax rebate on losses.

    My final point to make is you don't need to physically pay down the entire investment loan to $0, all you need to do is actively pay down your investment loans to the point where they are "truly" positive cashflow. That is when rent received covers ALL costs (not just interest payments) but P&I repayments, repairs, rates, insurances, land tax, management fees etc etc. At this point you don't need to actively plow your after-tax income into that investment loan anymore as it is a truly self-sustaining property. This usually occurs somewhere around the 50-60 LVR mark (depending on the property itself and the rental yield etc), so you really only need to focus on getting your investment loans down from 80-90 LVR to around 50 LVR and then your property portfolio will take care of itself.

    Your PPOR is going to take alot longer to pay down and you want any spare dollars to be in an offset account against your PPOR loan not any of your investment loans.

    Long story short, you're in a really great position to build wealth for yourself and your family in the future, especially if you can hold all 4 properties through another two property cycles or so but you can't afford to make these mistakes again, your broker should not be recommending/allowing for multiple loans to come off their IO period around the same time, no reasonable person can be expected to find $1000-2000 per month from their after tax dollars.

    If after 6-12 months you still feel like you're struggling with the P&I repayments, you could consider renting out your PPOR and renting a similar property in the same neighborhood (if you must live there) and that would provide your finances with a lot of relief (you would only need to fund the gap between the rent and the P&I repayments not the entire mortgage payment, interest/repairs/rates/insurances tax deductible, depreciation benefits), move back in within 6 years to your PPOR and still maintain the capital gains tax free status of your PPOR - win / win all round.

    Good luck on your journey mate, remember it's really a strategic game of managing/structuring finances - you need to make sure these banking/lending/interest-only etc mistakes are not repeated over the next two property cycles (15-25 years or so).

    • easoweno on 26/02/2018 - 14:39

      Thanks mate, I think you have solved what I couldn't figure out so far and I think I will take your advise for keeping 2 on IO and the other 2 on P+I. Can't really blame the broker though, we got into buying really aggressively during year 2014-15 and then consolidated 3 major loans to one bank, that's why they all expire around the same time too. But I have to say I wasn't thinking much about IO becoming P+I that's why we kept on buying. I am working towards what you say the self-sustaining IP and thanks for the crazy price growth in the last 3 years, 2 of the IPs are quite close to 40-50% in equity but still not quite sustainable yet. We do not want to rent out our PPR, nor do we want to rent, due to our family commitments (kids, parents, etc)… but hey, I mean when we really feel the urge to sell, to a point we can no longer afford it at all, then we can sell and I believe we will still make money, maybe not as much at the peak but who knows? IP gives us the opportunity to expand our portfolio and make a profit, it will take us ages to just rely on our day to day wages to achieve what we have profited in 3 years, so all is worth it.

      • CheapSticks on 13/06/2018 - 01:50

        Hi mate - may I know what interest rate did you get on investment property IO? Thx

  • MrBear on 24/02/2018 - 22:27
    +2

    So you are effectively $1.84m in debt because you thought it was a good idea to own 4 properties at the same time on a IO loan?

    It's bold strategy Cotton, let's see if it pays off for 'em…

  • jonnochen on 25/02/2018 - 09:54
    +2

    Holy shit. What are you going to do when interest rates inevitably go up?

    • easoweno on 26/02/2018 - 14:24

      I will sell if I have to if that makes sense, but currently I don't think I have to at the moment. the option to sell is always open.

      • jonnochen on 27/02/2018 - 08:54
        +1

        Ideally you don't want to be forced into that situation though because a time-pressured sale will likely result in less return for you guys. I thought I didn't mind a bit of risk, but whoa, I'd be stressed in your situation. Good on you for planning for the future though; just do it safely! :)

  • ABC730 on 05/06/2018 - 12:14
    +1

    Hi easoweno,

    Sorry if this is out of the blue. I'm contacting you from ABC's 7.30 program and I'd really like to have a chat with you about this over the phone. Please let me know if this is alright with you, we're just seeking some background on a story we're doing on interest only loans and will not be quoting you for anything. If you're alright with that, please email me on [email protected]

    Cheers

Login or Join to leave a comment
Login Join