“Gearing,” by definition, simply means to borrow money to buy an asset. For instance, when you take out a loan to buy a property, that’s gearing.
Basically, there are three types of gearing:
Negative gearing, where the interest you’re paying on the loan you took out is greater than the income you’re getting from the property you purchased. In other words, you’re operating at a loss.
Neutral gearing, where the interest you’re paying is the same as the income you’re getting.
Positive gearing, where the property you just purchased is generating income higher than the interest you’re repaying. In other words, you’re making a profit.
Looking at the definitions, it’s easy to wonder why anyone would want to get into a negative gearing situation. In truth, it’s actually a viable method to GAIN money, because the profit won’t come from rental income, but from capital gains.
Here’s how capital gains work. Let’s say you took out a $300,000 loan with a 7% annual interest rate to buy a property worth $350,000. That would mean every year, you’d have to pay $21,000 in interest.
Now let’s say you earned $300 in rent every week. That adds up to a total annual income of $15,600. Held against your annual interest payable of $21,000, you’ll end up with a deficit of $5,400 every year. That’s a negative gearing situation.
But then again, let’s say the property increased in value by 8% that same year. That brings its value up to $378,000, a growth of $28,000. Held against your $5,400 deficit, that’s still a net gain of $22,600.
That’s how people make money out of negative gearing, Used correctly, it can help you achieve your financial goals more quickly, as it puts another viable investment method on the table.