You might have heard the term "negative gearing" while doing your property investment research. If you're unsure of what it means, we're here to explain it to you.
Quite simply, gearing means borrowing money to invest in an asset.
Negative gearing is when you borrow money to invest in an asset, but the income you make from that investment is less than your interest repayments and other property related expenses.
So how does negative gearing work exactly? Let's imagine an HSBC investor named Kate.
Kate buys a property for $420,000 and gets a $380,000 loan at an interest rate of 5.50%. The annual interest payable on her loan is $20,900.
Kate rents out the property for $350 per week, which adds up to an annual rental income of $18,200.
Kate is paying $20,900 in interest and earning $18,200 in rent which means she has a shortfall of $2,700 each year. Because she's making a loss, it means her property is negatively geared. The shortfall amount doesn’t take into account additional property costs such as insurance and maintenance, which would be on top of the $2,700.
Because the income from your property won't cover all of your expenses, you need to have reliable cash flow.
This will make sure you can cover your mortgage repayments and allow for pre-tax borrowing costs. It also ensures you can cover any other expenses that might arise when you are managing your property.
Positive gearing is the opposite strategy, and the one most commonly adopted in Australia. This is when your rental income is higher than your expenses.
This investment strategy gives you consistent income that covers your mortgage repayments and other costs associated with owning property. Plus, you may still get any capital gain benefits if you sell your property and home values have risen.
Competition in the housing market may not necessarily always result in the positive gearing outcome you intended.
Investing in property is a big step in life so be sure to get independent financial advice or refer to the ATO and choose a strategy that suits you.
This article is intended to provide general information of an educational nature only. This information should not be relied upon as financial product advice as it does not take into account your individual objectives, financial situation or needs. You should consider the appropriateness of the information to your own circumstances and seek independent legal and financial advice prior to making any investment choice. There are risks associated with any investment and this document is not intended to list all of them in respect to any particular investment opportunity. Prices, levels and indications contained in this document are illustrative only and may not represent future performance. HSBC does not warrant or represent the performance of any investment opportunity.