Your guide to gearing
By Robert Wright /August 21,2023/
There are a number of considerations when it comes to gearing, the investment assets you may choose to gear and the way you structure your debt.
A gearing strategy can be set at three levels:
- Positive gearing – where income from the investment exceeds the interest payable on the loan.
- Neutral gearing – where income from the investment is equal to the interest payable on the loan.
- Negative gearing – where the income from the investment is less than the interest payable on the loan. The excess interest expense is an allowable deduction against other assessable income, which for a taxpayer on the top marginal rate is currently worth 47% (inclusive of the Medicare levy).
Investing in growth assets such as shares or property using borrowed funds can be one of the most effective ways to accumulate wealth over the long term.
Investors are solely relying on a future capital gain when undertaking a negative or neutral gearing strategy. Negative gearing is tax effective in that the interest expense is fully deductible against the income generated by the geared investment and other assessable income. There are also other tax breaks such as the deductibility of depreciation (for property) and franking credits (for shares) to help subsidise the cost of the investment. In addition, for individuals, 50% of any capital gain is exempt from tax where the investment is held for at least 12 months.
Positive gearing strategy
If $100,000 were invested for a year in assets that produced a return on investment of 10% per annum, the total return on investment would be $10,000.
If the investor had also used a gearing strategy and borrowed $50,000 (at a cost of 7% per annum) and invested this in the same assets producing the same 10% per annum return, the return on investment would be 10%, less the cost of finance (7%) – that is, a net additional return of $1,500 using someone else’s money.
The net return can be greater than this when the tax deductibility of interest is taken into consideration.
The below examples of negative gearing illustrate how the negative cash flow from the investment can be offset by the deductibility of interest plus other tax breaks.
Negative gearing an investment property
Sarah earns a salary of $200,000 and borrows $400,000 to buy an investment property. The property generates rental income of $20,000 per annum while interest expense on the loan (interest only with no principal repayments) is 7% or $28,000 per annum. In addition to the deductible interest expense, there are the following ‘non-cash’ deductions:
- $2,500 depreciation
- $4,500 building amortisation (2.5% based on a construction cost of $180,000)
|Financial position||Without negative gearing strategy||With negative gearing strategy|
|Non-cash property deductions||–||$7,000|
|Tax payable (incl. Medicare levy)||$64,667||$57,617|
The difference in cash flow of only $950 has been assisted by the $7,000 tax deduction for the non-cash depreciation and building amortisation expenses.
These examples demonstrate the worth of tax deductions to an individual on the top marginal tax rate in the first year of a negative gearing strategy. Over time, negatively geared investments can become positively geared – especially when rental income or dividends are reinvested.
Couples with one person on a higher marginal tax rate than the other, should carefully consider who should be the borrower and owner of investments over the long term. While initially it may be tax effective to have a negatively geared investment in the name of the person with the highest tax rate, if it’s expected to become positively geared in the future, it may be more effective to have the loan and investment in the name of the person with the lower marginal tax rate from the outset. Especially when you consider the potential capital gains tax, stamp duty and loans fees that might be incurred in transferring the investment and loan.
Trusts and companies can also negatively gear investments, however the following should be considered:
- Trusts and companies cannot distribute losses, they need to be carried forward and offset against future assessable income.
- While the company tax rate is 30% for companies that are not base-rate entities which have a tax rate of 25%, companies are fully assessed on capital gains as opposed to the 50% discount applied to assets held for 12 months or more by individuals and trusts.
Negative gearing a share portfolio
Sarah earns a salary of $200,000 and borrows $400,000 to invest in a share portfolio. The share portfolio generates a dividend yield of 4% fully franked, while the interest expense on the loan (interest only loan) is 7% per annum under a line of credit secured against her home.
The below table illustrates the impact the negative gearing strategy has on Sarah’s cash flow.
|Financial position||Without negative gearing strategy||With negative gearing strategy|
|Imputation gross up||–||$6,857|
|Tax payable (incl. Medicare levy)||$64,667||$62,250|
|Tax payable (incl. Medicare levy) and after franking credit||$64,667||$55,393|
The difference in cash flow is $2,726 which is approximately 0.7% of the investment portfolio. Sarah hopes that her after-tax capital gain will be greater than this cash flow loss.
What to do when your fixed rate home loan term is ending
By Robert Wright /May 19,2023/
Many Australians were fortunate to lock in record low interest rates but this may be drawing to an end.
A large portion of mortgages will be approaching the end of their fixed term, leaving many households paying two to three times their current fixed rate.
In this article, we’ll explain what to expect when your fixed interest rate ends and how to prepare for it.
What happens when your fixed rate home loan ends?
When your fixed term is nearing its end, you’ll need to decide whether to re-fix your loan at a new rate, change to a variable rate or consider switching to a new mortgage provider.
If you don’t do anything before the fixed term lapses, on expiry your mortgage provider generally switches your loan to its standard variable rate, which can be much higher than some of the discounted options available to new customers.
The best thing to do is contact your provider and ask them about your options, including what rates they can offer you.
How to prepare
Consider reviewing your mortgage at least 3 months before the fixed rate expires, as this will give you time to implement changes if required.
Here are some steps to go about this:
1. Negotiate with your current mortgage provider
It’s worth speaking to your current provider in advance to find out what variable rate you’ll be paying. This gives you an opportunity to check out other rates available in the market and think about whether switching providers is a better solution.
You can also see if you can negotiate a better rate as this may save you a lot of effort in moving to a new provider.
2. Research what other mortgage providers are offering
Now is a good time to see how your loan stacks up against other loans out there. This will help you determine if you’re getting a competitive interest rate.
If you do find a better offer, switching providers can be a smart move but it’s important to look at the costs involved in switching, borrowing costs and switching fees, as these can often outweigh the benefits.
Before you make any decisions, crunch the numbers with an online mortgage switching calculator.
3. Consider re-fixing your loan
If you like the predictability that comes with a fixed rate loan, you can re-fix your mortgage with an up to date interest rate.
However, you will be locked into the new fixed interest rate for a period of your loan term, unless you choose to end the contract earlier which may result in break costs.
Be sure to also carefully check out the features of a fixed loan too, such as fee-free extra repayments, redraw and linked offset accounts. Many fixed rate loans do not provide these features.
4. Consider a split loan
If you’re struggling to decide between a variable or fixed rate, or if you’re keen on a combination of flexibility plus certainty, you can choose to have part of your mortgage fixed and part of it variable.
For example, you could have 60% of your loan on a fixed rate and 40% on a variable rate.
This approach can provide the best of both worlds. The variable rate component gives you flexibility, while the fixed portion shelters part of your loan from rising interest rates.
5. Get help from an expert
If you can’t decide which option is best for you, a mortgage expert may be able to steer you in the right direction.
Mortgage experts can look at your finances and recommend some of the best home loan options to suit your specific needs. They’ll also be able to guide you through switching to another provider if that’s the path you choose to take.
Get a home loan health check
A home loan health check could help you to:
- find ways to fine tune your loan
- get more certainty or flexibility on interest rate options
- reduce your repayments
- pay off your loan sooner.
6. Make extra repayments before your fixed rate ends
If it’s possible for you to do so, consider paying off as much of your mortgage as possible before you’re hit with a higher interest rate.
By reducing your mortgage balance before your interest rate increases, you could save a lot of money on interest payments before it moves to the new rate.
How to manage higher repayments
When your fixed mortgage rate finishes and your repayments start increasing, your finances may need to be reviewed to cope with the new reality of rising interest rates.
There are ways to help you save and potentially earn more money, which may compensate for the rate increase.
1. Review your budget
While it may not be an option for everyone, there are expenses you can cut back on such as:
- taking public transport to work to reduce petrol costs and parking
- online shopping habits
- expensive memberships that you don’t regularly use
- taking advantage of government and council rebates to reduce your energy bill
- switching to energy efficient appliances and lightbulbs
- reviewing your utility and insurance providers – there may be better deals on offer which could save you hundreds of dollars.
2. Increase your income
Looking for ways to increase your income can help you manage higher repayments once your fixed rate expires.
Consider asking your manager for a salary raise or look for a higher paying job.
You could also consider starting a side hustle like dog walking or online tutoring to make extra cash. Another option is to rent out a room or parking space.
3. Consider opening an offset account
An offset account is like a transactional savings account linked to your mortgage balance. The funds in this account can reduce the amount of interest you pay on your mortgage, so holding your savings here can be beneficial.
For example, if you have a $600,000 mortgage balance and $100,000 in your offset account, you’ll only be charged interest on $500,000.
How ‘Buy Now Pay Later’ affects your credit score
By Robert Wright /November 23,2021/
In recent years, ‘buy now pay later’ (BNPL) has become an increasingly popular method for consumers looking to purchase goods via instalments without resorting to credit cards.
These services are often billed as a safer and more convenient way for consumers to manage their spending, and their popularity has led them to become widely available.
But if you miss a payment or misunderstand the particular terms you’re agreeing to, BNPL has the potential to dent your credit score and impact your lending ability down the track.
What is BNPL?
The BNPL market is growing exponentially. Valued at $43 billion, this sector has tripled over the previous two financial years, according to the Reserve Bank of Australia.
BNPL schemes allow consumers to buy goods and services from a retailer by only paying a fraction of the price at the time of the transaction and the rest of the payments in instalments. This convenient payment method offers interest-free payments to consumers and is currently attracting considerable attention. However, if you miss payments, you could be in trouble.
In the 2018-19 financial year, the total revenue from missed payments from all BNPL providers totalled over $43 million, a 38 per cent increase from the previous financial year.
Many people, especially younger consumers, have a general understanding of what a credit score is and that a bad credit score, or rating, can affect their ability to secure loans or lines of credit.
What they may not realise is that almost every transaction they make has the potential to impact their credit score – whether it is paying a utility bill late, carrying a lot of ‘contract debt’ by upgrading your phone every year on a plan, regularly overdrawing your bank account and using overdraft, or having multiple credit cards and only paying the minimum monthly fee.
All of these factors are taken into consideration to give a picture of your spending habits and determine whether you are a desirable candidate to lend money to. So, while it may not seem like a big deal if you pay your electricity bill a few days late, or you’ve signed up to a five year plan to pay off the latest iPhone, or regularly using BNPL services to pay for things, these actions may be chipping away at your credit rating which could cause issues when it comes to seeking a home loan down the track.
Improving your credit score
The first step is to go online and check your credit report. This is generally a free process, and everyone is entitled to one get a credit report once a year. Ensure all your personal details and queries on your credit history are correct. However, beware of any credit repair companies that claim to improve your credit score. This is simply ineffective and a rip-off.
Here are some steps to help you improve your credit score and make yourself a more desirable loan candidate if you expect to be applying for a home loan in the near future.
- Resist the lure of BNPL and other easy spending
To avoid additional scrutiny of your personal spending habits, it may be better to close your BNPL accounts and focus on only purchasing things you can pay for in full. Resist the urge to upgrade your phone unnecessarily so you can pay out your existing plan.
- Limit the amount of credit applications
In the year leading up to your mortgage application, be cautious of applying for credit. It is advised to wait until after your loan has settled to then apply for credit and take advantage of interest-free loans.
- Close any unused credit cards
If you have any unused credit cards, it is advisable to close them to increase your borrowing capacity. When assessing your loan application, a lender will often assume all credit limits are fully drawn and will count the minimum payment as an expense. This may be the difference between getting the loan or not.
- Demonstrate stability in employment and residency
Staying in the same workplace and household for at least six months is key to obtaining a home loan. Banks like to see stability, and moving jobs or houses can compromise getting a loan approved.
Source: Money & Life
Spring clean your credit rating
By Robert Wright /November 23,2021/
Is your credit rating looking a little worse for wear? Here are our tips to help you get it back into shape ahead of your next big purchase.
What is a credit score?
Lenders use your credit score to work out how reliable you’re going to be as a borrower. Whether it’s for a home loan, personal loan or credit card, having a good credit score means lenders will be more likely to lend you money. A poor credit score will make it harder for you to borrow money, as lenders might view you as a higher risk. You may even have to pay a higher rate of interest than someone with a good credit score.
How can I check my credit score?
Your credit score is found in your credit report, which is held on file by credit reporting agencies. You’re entitled to a free copy of your credit report once every three months. You can get it from these three credit reporting agencies:
- illion (formerly Dun & Bradstreet)
Each agency calculates your score slightly differently, and may hold different information about you, so it’s worth checking with each.
How is my credit score calculated?
Your credit score is based on your personal financial information, which is collected from lenders, service providers and public records. Things that can influence your score include:
- how much you owe and the type of borrowings
- how many credit applications you make
- whether you make repayments on time
- whether you’ve defaulted on any debts in the last 5-7 years
- any bankruptcies, court judgments or personal insolvency agreements in your name.
From 1 July 2021, comprehensive credit reporting (CCR) became mandatory for the major lenders, requiring them to provide more detailed information about your financial history, such as:
- any credit products you’ve held in the last two years
- your usual repayment amount
- how often you make repayments and whether you pay on time.
From 1 July 2022, lenders will be required to also provide financial hardship information. The CCR scheme aims to give lenders a more accurate picture of your capacity and ability to repay credit.
Great, so how can I improve my credit score?
Finding out that you have a low credit score can be worrying. Fortunately, there are steps you can take to improve your credit score and keep it high:
- Pay your bills on time
Always pay bills like utilities, rent, mortgage, tv, internet and phone services on time, especially if the bill is worth more than $150. If a bill costs over $150 and is at least 60 days overdue, a default can be listed on your report, which remains there for five years.
- Pay credit card, loan and other debt repayments on time
Making debt repayments on time and in full shows lenders that you can be trusted to meet your obligations. Having a good repayment history can even help boost your credit score, for example, paying off your credit card in full each month.
- Limit how many credit applications you make
Every time you apply for credit, such as a new loan, credit or store card, the application is listed on your credit report. Making lots of applications in a short space of time may affect your score, as it looks like you’re in credit distress. Only apply for credit if you genuinely need it.
- Pay off your debts
It’s generally the case that the less debt you’re carrying, the better your borrowing capacity is. So pay off your personal loans, close credit and store cards that you’re not using and reduce the limits on any other credit cards you hold.
- Fix errors on your report
Finally, it’s worth checking your full credit report carefully to make sure that it’s accurate. From time to time, incorrect information can be added to your report, which can negatively impact your credit score. If you do notice an error on your report, contact the credit provider and/or credit reporting agency and ask them to amend your report. Avoid using a third party ‘credit repair’ company to clean up your report, as they are only doing what you can do yourself for free.
By taking these simple steps, you can expect to see your credit rating improve gradually, over time. However, if you’re having trouble paying your bills on time, struggling to manage debt or having other financial difficulties, seek help from a financial counsellor as soon as possible.
Source: Money & Life