What is gearing and how can I use it to invest in property?

Answer

The term gearing simply means borrowing money to invest—you can borrow to invest in an investment property, a business, shares or managed funds.

Borrowing to invest increases your credit risk significantly but it can potentially help you build wealth faster. For example, rather than saving to buy an investment property, most people borrow a large portion of the property price with the aim of getting into the property market more quickly and achieving capital growth if the property’s value increases.

An investment can be negatively, neutrally or positively geared depending on the relationship between the costs of owning the investment property and the income generated. We explain the differences.

Negative gearing explained

What is it?

When the interest payments and other costs that you incur are higher than the income you receive from the investment. That is, you make a loss.

How can it affect my tax obligations?

That loss can reduce your taxable income. You can typically claim a tax deduction for the interest and many of the costs of your investment, which may reduce the overall tax you pay on your other income, such as employment income.

The higher your marginal tax rate, the greater the dollar value of the loss will be to you. So negative gearing can be particularly attractive for investors who have high marginal tax rates.

But don’t forget, if your property is negatively geared you’re still making a loss. For negative gearing to work, the investment needs to gain enough in value during the time you hold it to offset the losses you make along the way. This means negative gearing can be a risky strategy, particularly if your situation changes and you can’t service the debt as easily.

Neutral gearing explained

What is it?

When the interest payments and other costs are equal to the income you receive from the investment. You break even on your investment.

How can it affect my tax obligations?

Neutrally geared properties have no real tax implications.

Positive gearing explained

What is it?

When the interest payments and other costs are lower than the income you receive from the investment.

How can it affect my tax obligations?

You can claim a tax deduction for the interest and other costs against your investment income. However, the taxable income generated will be subject to income tax at your marginal tax rate. You won’t be able to reduce the tax you pay on your other income. However, you can use the surplus income to reduce the size of your loan.

Effectively gearing your investments

How and whether you can use gearing will depend on your circumstances. Generally an effectively geared investment:

  • needs a reliable cash flow to cover pre-tax borrowing costs
  • has an investment timeframe of at least five years to make the most of the investment’s potential to build wealth (but it depends on the type of investment you choose)
  • generates a reliable, long-term income
  • needs to gain enough in value (capital growth) during the time it is held
  • provides income growth and becomes positively geared—ideally as debt decreases the investment’s yield increases (eg. rent from an investment property) so you’re earning more but may have to pay more tax.

If you’re thinking about investing in property you need to demonstrate an ability to repay the loan, including during times when the property may be vacant or interest rates rise. Some lenders may not take potential rental income into account when determining your ability to repay the loan.

And it pays to be aware that while borrowing money to invest delivers the potential for greater returns there is also the chance of an increase in the risk of losses too. Before considering a gearing strategy, speak to your financial adviser to ensure you understand the potential risks and benefits involved. And, if you don't have one, you can call us on 131 267 or use our find an adviser tool to locate one nearby.
 

 

Cost of home loan calculator

Our Cost of home loan calculator allows you to determine your loan repayments and the total cost of fees.

Calculate now

AMP Bank home loan options for you

Find out more

Learning module
Buying a home

Visit our learning zone

Important information

Show more

It’s important to consider your particular circumstances and read the relevant Product Disclosure Statement or Terms and Conditions before deciding what’s right for you. This information hasn’t taken your circumstances into account.

This information is provided by AMP Life Limited. Read our Financial Services Guide for information about our services, including the fees and other benefits that AMP companies and their representatives may receive in relation to products and services provided to you. All information on this website is subject to change without notice.