Nayade .

Introduction

When you apply for a loan, you will often have to choose between Principal & Interest (Principal & Interest) payments and Interest Only repayments. As the name suggests, with Principal & Interest payments, you are paying your lender the interest cost for the month plus a portion of the principal you have borrowed. Over time, your loan balance will reduce. With Interest Only payments, you are only paying your lender the interest cost for the month so your loan balance will not reduce.

The type of payment you choose (between Principal & Interest and Interest Only) is likely to impact the interest rate you are charged. In the data below, sourced from the RBA’s most recent set of statistical tables (current as at October 2020), you can see that there is a 0.7% pa premium to have an Interest Only facility compared to a Principal & Interest facility.

Further, depending upon a lender’s perception of the current market risk as well as your personal risk, they might not be willing to offer you an Interest Only option, preferring you to take up a Principal & Interest facility.

Lenders typically favour Principal & Interest as it reduces your loan and therefore their exposure over time. It also fits in nicely with their expected end goal: that your loan is repaid. Whilst you can repay your loan by selling your property or refinancing with another lender, repayment of the loan in a steady repayment stream over the life of the loan is often seen as preferable by lenders.

Principal and Interest Payments

Features

– The monthly repayment is based on the current interest rate, the loan term and the balance required at the end of the loan term. For a Variable Rate loan over a typical 25 loan term, the balance at the end of the loan term is normally set at nil. If, however, you had an Interest Only facility for the first three years of your loan, the Principal & Interest monthly payment amount for the remainder of your 25-year loan would be higher than if you opted for a Principal & Interest facility from Day 1 as there will be three years fewer in which to repay the principal amount.

– As can be seen below, the amount of the Principal & Interest repayment devoted to repayment of the principal increases over time as the interest is calculated on the principal balance remaining at the end of each month.

Note: This analysis excludes fees and charges.

– The higher the interest rate at the time you take out the loan, the higher the overall repayment and the greater the proportion of the repayment which will be devoted to paying the interest (and proportionally less will be devoted to the repayment of the principal).

Note: This analysis excludes fees and charges.

Pros of Principal & Interest Payments

– As noted from the RBA data, you may receive a lower interest rate so more of your repayment can be allocated to a reduction in principal. For example, over a year, for a $500,000 loan, if the Principal & Interest rate is 0.5% pa interest rate lower than the Interest Only interest rate, then this difference can be used to repay a further $2,500 in principal.

– Because Principal & Interest payments are considered more prudent by lenders, a loan with a Principal & Interest facility is often easier to obtain.

– Every time you make a reduction in the principal owing, there is a compound effect on the amount of future interest you have to pay as with Principal & Interest, the interest you pay is based on the balance of the loan outstanding at the beginning of the month. (This is why making additional or slightly higher payments each month is recommended as the benefit of the principal reduction has a compounding effect for the balance of the loan period).

– There is an inherent reduction in stress levels when you are reducing the principal owing – sometimes the satisfaction of seeing the balance reducing can give you a nice internal smile at the end of a day!

Cons of Principal & Interest Payments

– Your cash payment is higher each month as you are paying your interest plus a portion of the principal you borrowed.

– For Investors, part of your cash flow is tied up on non-tax deductible repayments (i.e. the repayment of the principal). Please seek independent tax advice before considering this issue.

Interest Only Payments

Features

– Each month, you only pay the lender the interest you owe.

– At the end of the month, the same amount is owing to the lender as was owing at the start of the month – and this does not change during the term of the Interest Only loan.

Pros of Interest Only Payments

– You do not need as much cash flow available each month to make the monthly payments.

– There may be tax deductible benefits for Investors. For this, please seek independent tax advice.

Cons of Interest Only Payments

– As noted in the RBA data, your interest rate may be higher than if you had selected a Principal & Interest product.

– It can be harder to obtain than a Principal & Interest product as many lenders have a natural bias in favour of Principal & Interest products.

– Your loan balance does not reduce.

– In times of tough economic conditions, if housing prices suffer a fall in value, you may find it harder to obtain refinance as your loan to value ratio (LVR) may have increased more than if you were paying Principal & Interest payments.

– When it comes time to revert to a Principal & Interest repayment, your payments will be higher than you would have paid at the beginning of your loan. Based on the above examples, at an interest rate of 3.0% pa, on a $750,000 loan over 25 years, the Principal & Interest payment is $3,556 per month. If you had a 5-year Interest Only product and then reverted to Principal & Interest at the end of the 5-year period, your Principal & Interest payment for the remaining 20 years would be $4,159 – an increase of $603 per month.

– An Interest Only facility can be more stressful for some borrowers who like to see some gains for all the money they pay out in interest as the amount they owe their lender does not decrease.

Our take

– This is the same as our view for variable and fixed rates.

– While lower repayments for an Interest Only facility can seem intuitively better as you reduce the impact on your monthly cashflow, you are also delaying the repayment of the principal and so you are paying more in interest. For some borrowers, this trade-off is worth it as it allows them to enter the housing market and get started; or, it allows them to maximise the benefit of potential tax advantages if they are an Investor (again, seek independent tax advice on this issue).

– As with our comments on variable and fixed rates, it is important to note that everyone is different and everyone’s appetite for risk is different so there is no ‘one answer is correct’ advice. And, when you are dealing with joint applicants, you need to take into account the risk profile of each applicant. Just because one applicant might be comfortable with a higher level of perceived risk, the other applicant might be a little bit more conservative; so you need to balance the attitudes of both applicants.

– As part of our due diligence when we assist you in identifying a suitable loan, we undertake a Needs Analysis for each person applying. We ask you what your level of concern is about rising interest rates. We also ask you if you would like to consider a fixed rate loan, either in part or in full, and we go through with you all the features, pros and cons.

– We always ask ’Who is on your team?’. What we want to know is, have you got a great team of advisors to assist you in making important decisions? Because when you are dealing with loans of hundreds of thousands of dollars, you need knowledgeable, ethical professionals advising you of your risks.

Before we start….

For further content, please visit https://www.bir.net.au/blog/

And, if you would like a Free Property Report, you can order yours here: https://www.bir.net.au/report-request. You can obtain a report for a particular property, suburb or region in Australia, so you can make informed property decisions. Plus, our suburb reports now provide a comparison report of up to 5 suburbs you want to research.

Any questions, please ring me, Michael Royal 0411 190 474 or email me: michael.royal@bir.net.au. And you can also book a meeting with me: https://calendly.com/michael-royal/chat-re-finance

Now, back to the Article! 😉

Interest – what is it?

Interest rates reflect the price of money. The interest rate ‘price’ factors in a large number of variables including the lenders’ competitive environment and their need to be profitable.

Unlike most transactions with a supplier, your financial umbilical cord with a lender lasts a very long time – often up to 30 years. This element of time differentiates a lending product from most other consumer products. When you borrow money from a lender, there is an expectation by the lender that you will pay them back in full on the terms you have agreed and that you will also pay them ‘the price’ – or interest charges – for borrowing their money over the term of the loan.

Whilst it is arguable the ‘time risk’ reduces as years go by as property prices tend to increase and loan balances tend to decrease, there is an inherent risk, particularly in the early years of a loan. Lenders protect themselves from the potential risk of handing over large quantities of money by adding a margin on the interest rate they charge. Some won’t lend to particular types of borrowers because of the perceived risk.

What we know about interest

1. The longer the term of your loan, the more you will pay in interest. Interest rates matter, but so does the term of your loan. That is why when you consolidate your debts from higher interest credit cards into your lower interest home loan, it is important to pay off the debt you consolidated into your home loan as quickly as possible. If you pay it off over the full term of your home loan, you may well end up paying more in interest than if you paid it off over a much shorter period at higher interest rates.

For example, a credit card/personal loan debt of $100K incurring interest charges of 18% pa, will incur an interest expense of $18K over 12 months. The same debt, paid off over 25 years as part of your home loan at 3.0% pa, would cost $42K in interest . Even allowing for the ‘time cost of money’ (i.e. a dollar today is worth more than a dollar in the future), this is a large difference.

It is also why paying additional amounts or slightly higher amounts each month than you are contractually obligated to pay is recommended. You will reduce your principal more quickly and thus pay less total interest.

For example, a $750K loan paid off over 25 years on a P&I basis at 3.0% pa interest, will incur $317K in interest charges. If the loan term is 20 years, with the same interest rate, the interest charges will be $228K – $89K less.

2. Interest is the main expense charged by a lender. But it is not the only one. Whilst other costs such as monthly fees and charges, annual establishment fees etc might appear minor, they still have to be paid.

3. Interest rates change over time. Even fixed rates are only for a limited time (generally up to a maximum of five years). When you enter into a loan agreement with a lender, make sure you can afford the loan and allow for any increases in the interest rate. Our interest rates are at historical lows but less than 10 years ago rates for home loans were in the high single digits. And, for those old enough to remember ‘the recession we had to have’ in the early 1990s, you will recall rates of well over 15% pa with the highest rates an eye-watering 20%+!.

Michael Royal, our Senior Finance Specialist, is a member of BNI Powerhouse which is based in Altona VIC 3018. Below is a list of members in his BNI chapter. These are business owners Michael has developed a deeper relationship with and he has either used them himself or others he knows have used them and recommend them as quality suppliers of the services they offer.

BNI – some background and context

BNI is a worldwide referral network for business owners who are looking to grow their business. There are over 288,000 members across the globe and many of the members are business owners who are looking to grow their business.

As most of us know, small businesses grow their business by referrals from clients, and fellow business owners they interact with.

But referrals don’t just happen. A referral is only made by someone if they believe the referral is someone who delivers quality services on time and at a fair price. And, when some refers to someone of quality, they are also seen in a favourable light as they become what is often known as a trusted business advisor.

In BNI, the referral process is known as Givers Gain. When I give something of value to my fellow members, in return I will receive something of value. A famous author and psychologist, Robert Cialdini, characterised this as the power of reciprocity.

This power of reciprocity ultimately as two important benefits:

1. The emotional benefit of helping someone achieve a better result. This benefit is experienced by both the ‘referrer’ and the ‘referee’.

2. The financial benefit for the referee from the business they receive.

Interestingly, at a member level, BNI does not measure and track the benefit received but rather, they measure the benefit given as the emphasis is on ‘who can I help?’ not ‘what’s in it for me?’

The total emotional benefit? Immeasurable; the total financial benefit? Over USD$18B in 2021.

Business who are my fellow members at BNI Powerhouse

Michael’s BNI Chapter is looking for business owners in the following specific business categories. There may be others you know so please don’t limit your thoughts to the categories listed below!

So, if you know quality service providers in any of the categories listed below, please reach out to Michael: 1300 989 878 or visit Contact Us

Real Estate / Property / Finance

✔️ Cleaner – windows, facades & solar panels

✔️ Commercial Finance Broker

✔️ Property Inspector

✔️ Residential Mortgage Broker

✔️ Property Manager

✔️ Rubbish removals – building & construction

Finance: Business and Personal

✔️ Accountant – Tax

✔️ Bookkeeper

✔️ Business Advisor

Business Services

✔️ Digital Marketing

✔️ Organisation & Process Engineering

✔️ Registered Sporting in Body

✔️ IT Support

Trades: Property, Business & Personal

✔️ Electrical – automation & security

✔️ Plumber – commercial

✔️ Tiler

Personal Services

✔️ Lawyer – Family Law & Mediation

Health & Wellness

✔️ NDIS – support coordination

✔️ NDIS – support worker services

✔️ Hypnotherapy

✔️ Massage Therapist

Background

James Spenceley co-founded wholesale telecommunications provider Vocus in 2007, and since then the company has exceeded his expectations, turning over profit every year, with 2008-09 revenue of $5.2 million. The company was listed on last year s SmartCompany Start Up Awards.

But the biggest improvement occurred only this year, when investment firm Investec bought the company for $20 million, and listed it on the ASX as Vocus Communications. Spenceley says the company is now able to pursue a number of expansion projects overseas that it couldn’t have done before.

The key, he says, is finding a good investor. Spenceley believes small businesses looking for investment should analyse themselves constantly and look for ways to make themselves attractive to larger, cashed-up companies.

Are you happy with the ASX listing this month?

Absolutely. We knew we had prepared, we thought the offer was reasonably priced, it was great to see such a good result from day one. We think it started off very, very strongly.

When did you first start looking for investment?

We always knew we wanted to have a big investor. One of the things I’ve noticed is that once you get a big investor, it adds a lot of value to the business. One of the things we were missing in our business was someone with a lot of financial markets expertise, and we think that s one of the areas Investec is great in. As we grew the company we knew we were lacking in that area.

Did you require the cash, or was it more that you wanted to look at new projects?

We laid the initial money for the company when we started, and our goal was to not lay any more cash until we were in a position to decide on our investor. Often companies have to raise money to do this, but Vocus performed well enough that we d never had to do that. By not raising money, we could wait for the right opportunity and this will help us grow.

I think that s key in any deal. When you need money you tend to try and take the first few that are available without considering the future, and that s something we’ve avoided with this deal.

How did the conversation with Investec start?

We were introduced by a third party. It went very positively. We just explained what our business was and what it did, and the Investec representative talked with us for awhile. They were looking for a telco, and we were looking for a serious partner so it was a good match.

Did you have any non-negotiable terms you wanted included, like full control?

That was one of the things we really wanted. I suppose we didn’t know them that well, and so you re obviously a bit suspicious of anyone new straight away. But we wanted to get control, if the partnership wasn’t working well we didn’t want terms dictated to us. Any deal we considered we wanted to include our core focus, which was growing the company quickly and not having anyone really interfere with that.

How did the decision to add former Oz Email chief executive David Spence to the board come about?

David didn’t come with the Investec people, that was an approach we made separately, but it was a good decision. He’s someone we’ve known for years, he is incredibly well-connected with the technical side of the business and it was the right time to bring someone on, now that we’ve made this deal. We needed someone with more financial expertise.

So identifying weaknesses was a big part of your decision-making process?

That’s one of the things we really looked at when deciding this. We know where we aren’t strong, and the financial side of the business is not something we were great at. I take the helicopter approach think about your board meetings from a downwards view who is interacting with you? Who s talking with you?

That was where David was a key decision for us, because he understands the financial world very well, he understands our industry. So rather than just having two sides of the table, opposed and talking across to each other, we have someone who knows both sides very well.

What advice do you have for small businesses looking for investment?

I think you’ve always got to have a plan. Think about where you need to be to get that investment, and then take as many steps early on to put you in that position. For us, it was making sure our financials were sound. We did an audit when we turned over just $150,000, but that audit showed others we were serious.

It s really important to take as many steps as you can. Do as many things as you can early on to get you into a position where you can present yourself for investment.

July 2010 by Patrick Stafford www.smartcompany.com.au

Would you like more information? You can ring us now 1300 989 878 or email us at moreinfoplease@bir.net.au

Robert Full’s TED video shows amazing close-ups of nature’s feet – that in itself is pretty inspiring for you to take a creative look at your business and your business strategies.

But this video really shines when you look closely: you will see that what you see is not all that is there. In fact, to draw from the video, what you think you see might lead you to incorrect conclusions if you don’t explore further.

This raised a question for me: How much of what we do in business and in life is based upon what we think we see rather than what is actually happening but which we cannot see?

Look at the video and think about your business in a new way.

Would you like more information? You can ring us now 1300 989 878 or email us at moreinfoplease@bir.net.au