What Is Gearing?

What is Gearing?
Gearing is borrowing money for a purpose, such as investment. By adding borrowed money to your own funds you can increase the total money available to use for a particular investment purpose. Therefore, gearing simply means borrowing. It provides an opportunity for you to increase your investment income and accelerate the value of your investments over time by using other people’s money (OPM).

Gearing for Property
The most common form of gearing is borrowing to invest in property such as the family home, or rental investment properties. Gearing can also be used for any other investments, including the purchase of shares or managed funds etc.

If you borrow 50% of the money to purchase an asset, then that asset is said to be 50% geared. If you borrow the full amount necessary to purchase an asset or investment, then the asset or investment is said to be fully geared. If you use some of your own money, as well as borrowed money, then the investments are partly geared. Gearing helps to increase the gain or the loss of an investment.

For example, if you have $10,000 invested in an asset and it increases in value by 10% the gain will be $1,000. But if you had borrowed $20,000, added that to your $10,000 then invested the total of $30,000, the 10% gain would have been $3,000.

The gain comes about if the 10% gain is higher than the percentage interest you have to pay on the gearing. That gain could be a capital gain due to increase of property values and if you carry out gearing properly it should result in a profit for you.

Types of Gearing
There are 3 types of gearing:

  • Negative gearing.
  • Positive gearing.
  • Neutral gearing.

Negative Gearing
Negative gearing is when the interest and costs of borrowing the money you have used to invest is greater than the income from that investment. The advantage of negative gearing to some people is that the loss, which is the result of the income being insufficient to cover the borrowing costs, results in a tax-deductible expense. This is beneficial if the growth and the value of your investment (e.g. property investment) is higher than the after tax expenses from that investment.

Positive Gearing
Positive gearing occurs when the income you receive from an investment is greater than the interest and other costs of gearing so that you end up making a profit.

Neutral Gearing
Neutral gearing is achieved when your investment income is equal to your investment costs. Your investment is then said to be self-funding and this puts you into a neutral position where you are making neither a loss nor a profit.