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Principal and interest pays down the loan, but are you really paying much of it at the start? Vast majority of that repayment is going to be interest. It's a more aggressive approach. There's a higher repayment and you are paying down the loan, which is going to build up equity on the property faster. The thing is, it's also a cheaper interest rate than what you get from an interest only product.
Nerd alert! Property nerds, the home for data-driven property investors, where we uncover Australia's hot and cold markets, latest headlines and trends. Welcome back to the Property Nerds podcast. And today we're getting deep into the finance world because property is a game of finance. And I've got none other than Jack Fouracre here from Fouracre Financial to help us unpack this.
And with the property investing world, the things that we're going to go into today are so important for property strategy. Because if you're scaling a portfolio, strategy is not just, should I go buy a house or a townhouse? Should I just buy in regional capital? Those aren't strategies. Like those aren't strategies.
They're just an outcome on a property-based decision. Strategy is micro. It's like you start getting lower and lower with like the finer decisions on finance. Because if you can have a strategic approach to finance and a strategy around what assets you acquire in what order, things start changing for you. So we're going to zoom in on the finance side.
And I want to start with the age-old debate, interest only versus P&I. And people listening to this might go, oh, that's simple stuff. It's not. Because we're going to go deeper than anyone's ever gone before on this stuff. People think about it just from the repayment level.
We're going to go about the finance, the policy, the repayment, the cost, the reasons, where it makes sense, where it doesn't. So you can have just absolutely the most clarity on your finance journey moving forward. So Jack, let's jump into it. Firstly, let's start from the top. What is an interest only loan?
And what's a P&I loan? Just so people aren't confused on what this is. Yep. So if you're looking at a 30-year loan term, both if it's principal and interest and interest only, principal and interest over 30 years, basically the interest is calculated daily that you have a repayment. Majority of that repayment is going to be the interest that's charged.
And then there's a small amount that's coming off the actual loan balance. And then over time, as the loan balance reduces, the interest portion goes down and the amount that's coming off the loan increases. So that's a principal and interest loan over 30 years. You can change that term. Some lenders doing 40 years, you can even go 20, 25.
But that's principal and interest, right? And that's the whole concept of I'm paying down my home loan. Yeah. Yeah. And now interest only is basically same, similar loan term.
You can choose your loan term, but you can also have one to 10, even one to 15 years interest only. Usually it's one to five years interest only. So what happens during that first initial period of being interest only is that you're not paying any principal off. You're just paying the interest portion. So the balance doesn't come down and yeah, it's interest only.
So after that interest only term, then it rolls over to P&I, principal and interest. Got it. And because it's on a shorter loan term, the P&I term, it's going to be a higher repayment. So you want to make sure that if you are coming up to an interest only expiry date that you want to look to reset that. Perfect.
Let's lock into one. So we're going to go into principal and interest mode. We're going to stay on there for a bit. We won't even talk to our friend interest only for a bit. Sweet.
All right. Principal and interest pays down the loan, but are you really paying much of it at the start? Nah, nah. At the start, it's vast majority of that repayment is going to be interest. Principal and interest, I actually like.
It's a more aggressive approach because you are going to be paying down the principal. You're going to pay, like there's a higher repayment and you are paying down the loan, which is going to build up equity on the property faster. The thing is, it's also a cheaper interest rate than what you get from an interest only product. Got it. Now we're jumping into the pros.
So the first one there is a cheaper interest rate. How much? Cheaper rate. Well, usually about 0. 3, depending on the lender, ranges between 0.
25 to 0. 5% of interest rate. So if we take like a 700K loan and if we just go 0. 3, we're looking at about $2,100 of interest saved in the year, which is not bad. It's pretty good.
So it's car insurance for free. But the difference in repayment from P&I to interest only be far more than that. Absolutely. So that's where the $2,100 in interest is saved. But if we have a look at this now and we go what the difference is.
So number one is the principal and interest loan. I'm just going to take a $700,000 loan and I'm going to make it a 6% interest rate. Then I'm going to look at the interest only loan at that 0. 3 higher at 6. 3.
So even though the interest only rate is higher, the repayment is still $523 a month lower, which equates to $6,270 less per year when you're interest only. You get that across three properties, it's 20K. So it is a chunky difference, even though the rate's cheaper. So that's one pro though. The rate's cheaper, but the con attached to that is the higher cost of managing it.
Let's talk about the next pro or maybe just the next bit of info on it is on principal and interest versus interest only. What is the servicing difference for some banks? And I say some intentionally because there are other banks that treat interest only differently. Let's talk about just bank scenario number one. Some broker goes, hey, because I kept it principal and interest, it improves your servicing by X.
What is that X? Yeah, so with the major banks and some non-major banks, having existing principal and interest loans helps with your serviceability for what you're applying for. Because when you're looking at the top tier lenders, if you have an interest only loan, they're not looking at that repayment. They're actually looking at what the repayment's going to be when it rolls over to principal and interest on the shorter loan term. So your borrowing power is actually worse with major banks if you have interest only loans.
And it's better if you have P&I existing loans. And so this is the part where people have to be careful with big banks specifically, how long their interest only term is. Because if you do a one-year interest only term, your servicing for that new property assumes that your loan's on a 29-year P&I. You do a three-year, it's 27-year. Five-year, it's 25 years.
So if we have a look at that, we'll break down some numbers now to help someone understand the difference. So let's do some numbers. So we're going to take the same $700,000 loan. We're going to keep the same 6% better interest rate, but we're going to look at this a little bit differently. So at the P&I term of 30 years, the bank sees it as $4197 per month.
At a 27-year term, the bank sees it as $4365, which is almost $6. 38 a month. And at the 25-year term, the bank sees it as $4,510 a month. Now, if we take that 25-year term of $4510 minus the higher amount or the lower amount at 30 years of $4197, that's a difference of $313 in their monthly servicing calculation. Now, Jack, what estimate loan amount would that change if someone's got a $313 per month shortfall in their servicing calcs?
How much does that equate? $150K. $150K. That's not small. Even if we bring it down just to be conservative, say some lenders got your back, it's $100K, $1,225.
Because if we take that $313 per month times that by 12 months, that's $3,756 in extra annual commitments. Now, that's not debt-to-income ratio. It's different. This is monthly impacts, right? So if we're looking at it from that perspective, circa $100K a month is huge.
Yeah. And some people might think, oh, so why wouldn't I just go P&I on all my cash outs and investment loans so I can get more borrowing with a major bank? Well, if you do set up everything interest only and then you have to go to a third-tier lender sooner than if you just put everything P&I, by having everything interest only, your repayments are going to be far less, even with third-tier lenders than if you kept everything P&I. So you could have $100K lower borrowing capacity by being on P&I and saving that little bit of a 0. 3, but then really you're not really saving it, you're saving it on interest, but that 0.
3 on the interest rate, your repayments are still higher by $6K a year. Okay. So now we look at that and we go, your borrowing capacity is better with the major banks. But now on P&I, let's talk about the other side, which is the borrowing capacity is worse with certain other banks that look at your repayment. So someone might be new to this and they go, what do you mean by repayment?
Let's talk interest only, where obviously the repayment is now not that $4,500, the repayment is $3, things start changing on what decisions you make. Could you talk about this dynamic of loan to value ratio as a way to think about the decisions you have and when it could sway more to interest only? Like, I think we're going to probably agree the 80% is sway more that way. But when it gets to 90 and above, what can happen with certain banks and their interest only policies that might not make it as worth for all people to stay there? Yeah, so I mean, not all banks allow you to go interest only at 90%.
So sometimes you're kind of limited to go to P&I for just the purchase. But if you've got existing loans that are interest only and you're going to the purchase and your servicing is a bit tight, no matter what the LVR is, you're going to get better servicing by doing P&I on the purchase. Because if all your existing loans are interest only, the purchase can still be P&I if you need that extra borrowing and lower rate. So what we're doing as well, sometimes, you know, if it's a 90% or servicing is a bit tight, we even go P&I over 40 years. So the repayment's still a little bit less because the extra 10 years on the loan term, but it gives you much better servicing, you know, on the purchase alone.
But, you know, at 90% and 97%, I can see certain clients that are not too concerned about cash flow. They more just want to be aggressive and gain equity. And they're kind of like, look, this purchase is going to be at a high LVR, 97%. I can't buy another property until this property gives me the equity to do so. So why go interest only in that scenario?
Why not go P&I? Because cash flow is not a problem. I need to build up equity as quick as possible. If I go P&I, it's going to be a cheaper rate. There's going to be less money in my pocket to pay for, you know, waste money on lifestyle and just more money goes into paying down the loan and building up equity faster.
This is big. People like wind this back. Wind this back. This is big because you're combining now the two reasons together. So the previous reason for interest only was to extend your servicing to acquire that next one to two properties.
But if you took out equity releases and you're not quite getting to 80% loan to value ratio for your purchase property and you're looking to get to 90%, firstly, you can unlock a lot more options of lenders by being at 80. And if you're going to go to 90, you can also unlock lenders who have more options if you're open to P&I. Because then for many that don't do interest only at that loan to value ratio. But the thing is, if you go to P&I in your purchase property, whilst you keep interest only for the others, you get the better rate is what you're saying. Secondly, you get better loan servicing because their rates can be quite wildly different for certain lenders who are pushing that limit of the next property.
And then also it forces you to save to pay that one down because there's a faster combination of payments down and growth. You get it from 90 to 80. That's your ticket to refinancing that property in two years and beyond. And if you do it within the first two years, you can get a partial LMI refund with certain lenders as well. You can get certain LMI refunds.
You can take it to two years and beyond or within two years. And then the main thing is if you hold it beyond two years, your broker will love you even more. But if you move it that two year mark and you go and then get to a normal lender, you could now not only bring it back to interest only, have a much better rate and then extend your servicing again for the next one because now the whole pool is interest only and that's moved from 90 to 80. And the interest rates, just for someone to realize the interest rates at some banks, when you go from 80 to 90, what can that switch be? How much of a saving could that be?
Yeah, usually around 0. 4%, 0. 3 to 0. 4%. Some lenders, it goes much higher than that, the variance, because lenders just have different appetites of what their book LVR is and what they're comfortable taking on.
So it's changing all the time. But I mean, there's certain banks where at 90% LVR or 97% LVR, their variable rates are really bad. Like in the eights as well these days, right? Yeah, yeah. But then when you fix it, you get it down to low sevens because their whole idea is that, yeah, if you go in a high LVR loan, then you are going to refinance within two years, which they don't like.
So if you fix it for one or two years, at least then they're comfortable that you're going to stay and they'll give you a cheaper rate. And that's fine to do. Because at the end of the day, being with a lender with a high interest rate isn't the bad thing. It's being with a lender for the high interest rate and not having a strategic exit strategy is the wrong thing. And that's what you're doing.
At the end of the day, by fixing it, you're getting a much better interest rate, but you also have your timed exit strategy. You go at the end of that fixed term, I'm going to review my options with my broker for a paper. And I'm going to go, I've got my two year fixed, I'm sitting with that lender, I shaved a percent off by being fixed, and I maybe even shaved another quarter percent off by being P&I. I'm forcing that loan down, I'm getting valuations up, and at the two year mark, this fix comes off, and at the two year mark, I'm having a review of it. Or if interest rates are hitting down and you're looking at that number, you might fix it for a year to get a benefit for the first year, and you assess it one by one by one.
Fix one year a lot for 97% LVRs. It helps when the growth is there, which it always is. But yeah, I saw one with a major bank. It was a 97%, the variable was 8. 3.
Fixed for one year, we got it down to 7. 2 or something like that. 97% investment. That's huge, right? So you're getting a low deposit in, and at 97% investment, you're getting 5% for the vendor, and so then 95% goes to them from the loan, or maybe 94%, and so 3% is lender's mortgage insurance.
Yeah, yeah. On a 97%, it's like 3. 5% cash deposit, 3. 5% LMI, 4% stamp duty. It works out to be like 11% total on the purchase price.
11% cash needed gets you everything sorted. Plus BA fees on the whole. Yeah, makes sense. Okay, cool. So now we're getting to a few layers on interest only P&I.
We've got the cash flow differences, we've got the servicing where P&I helps, we've got the servicing where interest only helps to extend it, and then we've got the strategic P&I on purchase but interest only on the rest, and loan to value ratio is considered to shave things off so you know when you can switch and refinance. The next thing I want to share with people is the concept of interest only from a point of inflation. So with interest only, from a point of inflation, here's what many people don't get, and one of our mutual friends, Jeremy, from the world of accounting, he's your accountant as well, right? So he's shared this one concept that's brilliant. In the 1980s or 1990s, if you'd asked a family member what your loan balance is, and they said, 50K.
Like, what the hell? You got a 50K loan? What's wrong with you? When are you going to pay that down? How are you going to pay that down?
That's a lot of lending. Yeah, all right. And then you ask that same person, you go, it's 2026, same property, same person, same human, just kept refinancing loans, interest only, kept changing it, kept shifting banks, kept moving it, had a broker that just kept them there. I'll get to it. I'll get to it.
I'll get to it. You then ask them going, hey, so how much is your property worth today? Million and a half? How much you buy it for? 100K?
80K? Back in the days? Okay. What do you got owing on it? 50K.
Only 50K? Yeah. Only 50K? See the difference? The loan number never changed.
The value changed, and inflation has also made that impact on the debt, because the inflation of the assets and the inflation rate as well means that the ability to pay off that debt at 50 is so much easier and perceived so little today, but it was a lot back then. And look, irrespective of interest rates, I'm not even bringing in the, I'm back in my day, interest rates are 17%. I'm not bringing in the interest rates today are high. I'm not bringing in the house price to income ratios. That doesn't matter.
None of that matters. All it is is a concept of that that person never paid their debt off their whole life, and today it feels worthless, that debt. That is inflation, and that's why so many people are interest only, because on P&I, you go and do a loan calculator.
