Take advantage of negative gearing with your investment property
Buying an investment property comes with a range of benefits, including rental income, potential capital gains and tax advantages that can be achieved through negative gearing.
Find out how to make your investment cash flow positive, the ins and outs of negative gearing and how to compare investment home loans.
How does a home loan fit into your negative gearing plans?
As interest repayments will make up the lion’s share of the costs of your investment property, you should try to minimise the interest rate you pay. The below example demonstrates how to retain the benefits of negative gearing while maintaining a positive cash flow.
Case study - Dimitri’s investment loan lesson
Dimitri has purchased a property in Sydney. He takes out an interest-only home loan of $400,000 at a rate of 5.50%p.a. His tenant moves in and pays $400 in rent each week.
Below is his current annual situation:
- Annual rental income: $20,800 ($400 x 52)
- Home loan repayments: $22,000
- Strata costs and other fees: $2,000
- Total cashflow position = - $3,200
Depreciation allowance: $4,000
= -$7,200 negatively geared
As you can see, Dimitri’s property is currently negatively geared and it is a negative cashflow property.
If Dimitri compared home loans and found himself one with a lower rate of 4.50%p.a, and continued interest-only repayments, the property would still be negatively geared. However, his property would be a positive cashflow property due to the lower interest repayments on his home loan.
- Annual rental income: $20,800 ($400 x 52)
- Home loan repayments: $18,000
- Strata costs and other fees: $2,000
- Total cashflow position = +$800
Depreciation allowance: $4000
= -$3,200 negatively geared
Dimitri can reduce his assessable income by $3,200 as a result. However, he will still be ahead by $800 a year rather than being out of pocket by $3,200 before depreciation is taken into account.
Dimitri is at least $2,040 better off as a result of the reduction to home loan interest, as the $4,000 in additional interest in the first scenario provides a maximum tax benefit of $1,960 if Dimitri is at the top tax rate of over $180k income (45% + Medicare 2% + budget repair levy 2%).
The benefit of negative gearing is tied to your income, so remember to consult your accountant before changing your investment strategy, as your tax situation could change.
How can I compare investment property home loans?
As you can see in the example above, Dimitri can get the tax deductions which come with a negatively geared property alongside a property which pays him an income.
He might also get other benefits if he chooses the right loan. Here’s how to compare investment home loans before signing on the dotted line:
- Interest rate. The key takeaway from the scenario above is that with a lower interest rate, you can benefit from increased income from your rental property, so you should carefully consider the interest rate of any home loan you’re looking at. When doing so, look at the comparison rate, as this will take into account the fees you’ll be paying and reflects the true cost of your loan.
- Fees. Carefully review the fees of the home loan. If you’re comparing home loans, ensure that the fees aren’t too high, otherwise this may offset the benefit of a lower interest rate. In particular, look at the upfront costs: fees such as application, valuation and settlement charges. Also, see if the loan has any ongoing fees or fees for offset accounts or redraw facilities if you use these features.
- Features. Home loans today come with a range of features which can help those looking to invest. These include 100% offset accounts, which are transaction accounts designed to help minimise the interest you pay when you leave funds in the account; interest-only options for as long as ten years, which remove the principal component of your loan repayments to reduce payments and increase tax savings; and the ability to split your rate between fixed and variable portions, so you can have more control over the costs of your repayments.
Home loan comparison
Compare some of the loans below to see how you might be able to save money by refinancing to a more competitive loan. By clicking the headings on the top of the table you can order home loans by interest rate, comparison rate, fees, maximum loan to value ratio (LVR), and monthly payment. Note that the monthly payment shown in the table will be for a principal and interest loan, and not an interest-only loan as shown in the scenario.
Note that the monthly payment shown in the table will be for a principal and interest loan, and not an interest-only loan as shown in the scenario.
Three things you should know about negative gearing with Brenton Tong
- Brenton Tong is Head of Strategy at Financial Spectrum.
- He's an expert in financial planning, estate planning, funds management, and insurance.
- Financial Spectrum is a boutique fee-based financial planning firm, which means they don't take commissions.
What are your tips for borrowers looking to reap negative gearing benefits?
Make sure you do your numbers first – as the old saying goes, measure twice, cut once. Be conservative and if you're unsure, ask for help. It's important that you have an understanding of the basic rules of tax. For example, if you're using equity rather than savings, make sure you borrow everything, including the fees and charges – it's often tempting to put savings into an investment to make it perform better, but putting savings into non-deductible debt is always going to be better.
Also, get a quantity surveyor's report for your property – don't guess on depreciation. You'll either miss out on valuable deductions or overstate them and not be able to justify them to the ATO.
What should new property investors consider before entering in the property market?
Be prepared for what we call the two months of pain. If the total cost of getting into an investment property is, say,
$60,000, then make sure you've got that plus the first two months mortgage payments – plus the ability to save more. It is very rare that you buy an investment property and the rental payments instantly cover the cost of your mortgage. It's more likely, especially
if it's a new property, that you'll take a few weeks to find a tenant, you'll have a few out of pocket expenses and the first mortgage payment will hit before you've had an income.
Ultimately, it's about making sure that the property that you're buying is affordable both in the short and long term. Consider if you have any changes in circumstances coming up.
An example may be if you're relying on two incomes to afford the investment property, but you're also considering starting a family and will therefore lose one income and have additional costs. While you might be able to afford it when you buy it, you may face cash flow challenges in the near future.
Make sure you do your numbers first – as the old saying goes, measure twice, cut once. Be conservative and if you're unsure, ask for help.
How can investors decide whether or not property is a good investment?
It all comes down to your overall long term strategy and what you're trying to achieve. You need to have the time frame
to hang onto the asset in case it does not perform the way that you want it to, and you need to be prepared to handle the risks (both financially and emotionally) of things like rising interest rates, losing a tenant and a possible decline in value which could
see your deposit wiped out. Investing and gearing into property is an excellent investment choice for the right people, and many people have profited greatly from it, but it's not without it's risks.
If you’re investing in a property, chances are you’ve spent a lot of time carefully studying the market to find a property worthy of your time and money. This is why it’s crucial to ensure your property is financed by a home loan which is low cost, while providing features you can benefit from. Start a comparison of home loans today and you may reap savings.