Investor's Strategy On I/O Vs P/I Repayments
Recently, most lenders have increased interest rates (for investment lending) as a way of recouping lost profits for having to retain more capital against their loan book. This was an order by the regulator APRA.
If you want to borrow money for investment purposes, you’re paying a price for it. At the present time it’s costing you anywhere between 27 to 50 basis points higher if borrowing for investment purposes.
The great news is that there are lenders who are pricing investment lending and owner-occupier lending on par, providing the repayments are set on a P&I basis.
Most investors choose I/O repayments, which makes sense as the idea is to pay off your home loan (non tax-deductible debt) first, before you starting paying principal off your investment lending.
So how do you beat the banks at their own game and level the playing field?
Here’s a possible strategy which may help you lower the cost of borrowing money for investment purposes.
Let’s assume you have an investment loan of $320k which relates to an investment property you own. The interest rate is currently 4.50% (if the loan was for owner-occupier purposes you would be paying around 4.20% at the present time).
After 5 years, the loan balance remains as $320k as the repayments are based on I/O (given that your loan is investment related).
Assume you gear the property to borrow an extra $30k and change the repayments to P&I to achieve a much lower interest rate. Your new monthly P&I repayments will be $1,773 as opposed to $1,200 per month (i.e. if you were still paying I/O at 4.50% at the original loan amount of $320k).
After 5 years, your loan balance is $320k which is the same as where your loan balance would have been if you remained on I/O at 4.50% (this scenario does not factor in the interest benefit on Offset funds).
At end of 5 years, your loan position is the same but with the benefit of a cheaper interest rate!!! (i.e. you’re paying 4.20% versus 4.50%).
A clever strategy which enables you to pay less interest. A saving of 30 basis points in fact.
For this strategy to work, you need to hold adequate equity in your investment property and not exceed 80% gearing, as the cost of LMI (which applies when borrowing > 80%) does not make it financially feasible. And you must have the borrowing power to borrow the extra $30k.
If you currently hold investment lending, or if you’re currently in the market to borrow money for investment purposes, then it’s important to be strategic with your finances to ensure you achieve lowest cost funding. After all, cash flow is the life blood of any business, and property investing is no different.
Contact us today if you want a confidential chat about your finance requirements and leverage off our combined extensive experience in assisting property investors with strategic finance advice.