If you’re investing in a property, you may have come across the term “gearing”. This simply means borrowing for the purpose of investing. If you borrow to make an investment it can be negatively geared - where interest repayments exceed net income, or positively geared where net income exceeds repayments.
In this article, we will help you understand what negative and positive gearing is all about, the difference between the two and the pros and cons:
Negative gearing means that the cost of owning an investment property outweighs the rental income it generates.
As an example, let’s assume that your rental property earns $20,000 in one year and the expenses of owning the property (loan repayments, body corporate fees, maintenance, etc.) are $25,000. You will have a loss of $5,000 which you can claim as a tax deduction.
One benefit of a negatively-geared property is the ability to claim tax deductions and reduce your taxable income. Additionally, a negatively geared property investment may appreciate in value over time.
There is also a risk involved with negative gearing because you are losing money. You will always need to budget for ongoing shortfalls and prepare for the losses.
Positive gearing occurs when the property is receiving more rental income from tenants than it costs to own and fund the property.
As an example, let’s say that your investment property is earning $20,000 a year, and your expenses (loan repayments, body corporate fees, maintenance, etc.) are only $15,000. You’ll have positive annual cash-flow of $5,000.
Obviously, the benefit of a positively geared property is the income. You don’t need to shell out any money from your salary for the expenses, and you can put your money elsewhere.
You're earning money from positive gearing, so this means you will pay more tax. The higher the income you generate, the higher your tax obligations will be. However, many positively geared properties are located in outer or regional areas, so your property may experience slower capital growth.
Be sure to have a good understanding of the effects of gearing before you buy an investment property. Your investment strategies should be aligned to your personal circumstances and risk preferences, and you should consider consulting with a financial adviser before purchasing an investment property. You can check out our investment property loan products and see which one will be perfect for you so you can start investing today.