How can gearing affect your borrowing capacity?

July 5, 2015 Sam Saggers

Top page content

4
This Top page contentLearn More

How can gearing affect your serviceability?

When we think about negative gearing, we think about the tax benefits it affords…especially those of us in the higher tax brackets.

What we might not think about is the impact it has on our ability to continue borrowing.

Following is an example of what can happen:

Borrower A

Salary: $ 50,000 per annum

Property purchased: $ 350,000

Rent: $300 per week

Interest rate: 7% variable

Property expenses are negative $5,000 per year (pre-tax)

The borrower may recoup their expenses at tax time, however, if they want to buy another property they may run into a problem with their lender.

This is why.

Typically, the lender looks at the income of $50,000, however it deducts the negative $5,000 from that income when doing calculations.

This means the buyer now only brings in $45,000 a year, which reduces the amount he can borrow, limiting his opportunities and ability to increase his portfolio.

Borrower B

Salary: $ 50,000 per annum

Property purchased: $ 350,000

Rent: $700 per week

Interest rate: 7% variable

Pre-tax cash flow of +$5,000 per annum

When the lender looks at this borrower, he sees the $50,000 per year salary PLUS the $5,000 per annum income via the investment property.

This means that the borrower now earns $55,000 per year, expanding his opportunities and improving the ability to grow his portfolio.

Is it “Positive Cash flow” or is it “Positively Geared”?

Interestingly enough, there is a difference, despite the fact that many people use these two terms interchangeably.

For a property to be considered “geared positively”, it must generate a return in excess of the liabilities on it, before any tax deductions are calculated.

A “positive cash flow” property is one wherein the positive return comes after taxes.

As illustrated in the examples above, there is a difference between the two financial situations when it comes to borrowing capacity.

To learn how to improve your borrowing capacity, visit us next Monday for our next blog: Top 10 Tips to Increasing Your Borrowing Capacity!

Bottom page content

8
This Bottom page contentLearn More
Previous Article
Top 7 Tips for Improving Your Borrowing Capacity
Top 7 Tips for Improving Your Borrowing Capacity

Top page content 4 This Top page contentLearn More How to Improve your...

Next Article
How to Slash your Tax
How to Slash your Tax

Top page content 4 This Top page contentLearn More Tax season is upon us…...