The Difference between Negative, Neutral, and Positive Gearing

Do you intend to purchase your first home? If so, you may be wondering what all the fuss is about with regard to "gearing," which is simply the amount of debt you take on in order to purchase an investment property. Moreover, gearing comes in three flavours: negative, neutral, and positive.

In this article, we will discuss the difference between negative, neutral, and positive gearing. You will also know which type of gearing would be best for you. So, keep reading to find out more!

What is Negative Gearing?

If a property is negatively geared, it has inherent tax benefits, as you can claim deductions exceeding the rental income you receive, meaning there's an overall tax loss. The key benefit here comes from a reduced taxable income and potentially lower tax rate, allowing investors to pay less taxes and pocket more of their money each year!

Advantages of Negative Gearing

Negative gearing is an incredibly common investment strategy for Australians looking to make more money from their rental properties. These are some of the advantages of negative gearing:

1. Investors can reduce their taxable income whilst building up a valuable asset by borrowing money to purchase a rental property and claiming the associated costs as tax deductions.
2. This can be incredibly advantageous for those looking to gain against the rising real estate market, as it allows them to leverage a much larger loan than they would otherwise be able to afford.
3. Furthermore, although risks are involved, provided you choose the right property, negative gearing is often the first step towards financial freedom.

Disadvantages of Negative Gearing

Negative gearing is an attractive opportunity for property investors, allowing them to offset the investment costs against their taxable income. However, it's important to consider the disadvantages too.

1. Investing in property using negative gear involves taking on considerable debt, so you may be risking a significant amount of money that could be put to better use elsewhere.
2. There's no guarantee that the value of your asset will continue to grow or even remain the same year-on-year. Suppose your rental income decreases or is insufficiently covering the cost of debts taken on for repair, upkeep and other obligations. In that case, you could find yourself in a tricky financial situation.
3. When it comes time to sell the property you have invested in with negative gear, you may be liable for capital gains tax depending on how much profit or loss has been made.

What is Neutral Gearing?

Neutral gearing allows taxpayers to bring in an equal amount of income and expenses, meaning their overall income will not be affected. This kind of financial strategy is beneficial for those who have investments and want to take advantage of both income and expense flows at the same time.

Ultimately, neutral gearing can help maximize long-term savings potential, yet it is wise to consider all the possible risks that come with this kind of financial strategy.

What is Positive Gearing?

A positively geared property is a great financial choice to have. In this situation, the rental income will be greater than the expenses that can be claimed, which leads to the taxable amount being favourable for the taxpayer. This means there is a surplus between what was earned and what it cost to earn it, allowing for extra profits.

Positively geared properties are great investments because they create a consistent flow of income without any detractions from your wallet. However, when deciding on such an investment, careful planning should be taken into account by calculating all costs and likely rental yields, as well as legal advice from qualified staff before signing on the dotted line.

Advantages of Positive Gearing

Positive gearing is a popular choice for investors as it can have many financial benefits. These are the advantages of positive gear:

1. Setting up a positive-geared investment means you receive more in rental income than you pay out in expenses and costs associated with the property - such as interest on the mortgage, rates, repairs and maintenance. 
2. Investing in positive geared properties can lead to good returns over time and benefit from capital growth from the asset itself. Additionally you can use money from rental income to help cover other costs or bills that you may have. 
3. Australian investors have used it successfully for many years. But before making this kind of investment you must do your homework and speak with knowledgeable experts.

Disadvantages of Positive Gearing

Positive gearing can be an attractive investment strategy. Although, it's essential to consider the potential disadvantages before jumping in. 

1. If the tenants fail to pay their rent on time or are continually late making payments, this can cause financial difficulties for the investor as cash flow will become restricted. 
2. Furthermore, with increased interest rates, investors may find that the income from rental needs to cover the mortgage costs, meaning additional expenses have to come out of pocket. 
3. There is no guarantee that capital growth will cover the expenses in a positive gearing situation, so there could be more loss than profit overall. As such, it is vital that any prospective investor carefully evaluate both sides before deciding if positive gear is a suitable strategy for them.

Which type of gearing is the best?

Deciding which type of gearing is the best for your financial situation depends on several factors. Negative gearing means you are borrowing more money than investing in something. Neutral gearing involves an equal exchange of funds borrowed and invested. Positive gearing means that you are investing more money than you are borrowing. 

Each type carries certain risks and rewards, so it's essential to research each option before deciding which is best for you. Ultimately, the best advice is to consult a financial advisor who can provide tailored advice based on your circumstances.

Conclusion

In summary, negative, neutral, and positive gearing are all ways to use debt to finance an asset. Each type of gearing has its benefits and drawbacks that should be considered before deciding. 

If you need help determining which type of gearing is best for your situation, our team at Unicorn Finance is happy to help. Contact us today for a free consultation!