What is negative gearing?
When you make a short term loss in the hope of a long term capital gain.
More people these days are taking out investment loans to buy investment properties or shares. Here we look at some of the things you need to consider when you borrow to invest.
Your priority should be your mortgage
Your home is a big investment and it's costing you a lot in interest. Instead of taking out an investment loan, consider whether it would make better financial sense to pay off your mortgage sooner.
Investment loans for investment properties
If you've paid off the mortgage on your home, you might consider borrowing to buy an investment property. An investment loan differs from a home loan in a couple of key ways.
Investment loans & home loans - the differences
In contrast to a home loan, costs associated with an investment loan are tax deductible (eg interest, repairs, rates, depreciation, etc). Of course, any rental income will generally increase your taxable income.
Capital gain on an investment property is taxable
There is another key way in which investment properties differ from residential homes. While the capital gain on your home isn't taxed, any appreciation in the value of an investment property will be.
Negative gearing - short-term loss for long-term gain
If you earn less from an investment property than it's costing you, you're said to be negatively geared. Why might you choose to make a loss? One reason is that it reduces your taxable income. The other is that you might accept a short-term loss in the hope of a capital gain later.
Share loans
Borrowing to invest in shares has become very popular. The Australian share market has been on an unprecedented bull run, and the interest on your loan is tax-deductible. But you need to be very careful and seek professional advice in this area.
What goes up
Just because shares have been growing at a very healthy rate for an extended period, there are no guarantees that they will continue to increase in value.
Margin loans
Many people use margin loans to buy shares. Here's how they work. Let's say you want to buy $75,000 worth of shares to invest in a WA mining firm. You could pay a $25,000 deposit, and take out a margin loan to pay for the remaining $50,000.
Margin calls
However, with a margin loan, if the value of the shares drops, you'll have to pay what is called a margin call. In simple terms, you'll have to pay the lender the difference between what you paid for the shares, and the amount they are now worth.
Borrowing to invest
Once you have decided on your investment strategy, an MFAA member can help you find an appropriate Investment loan. MFAA members are the Essentials of Borrowing. Talk to an MFAA member today.
Want a business finance tip?
Business finance: finance brokers. Check out Essential #31
