Using the equity in your home
There are both benefits and risks involved when releasing equity in your home. You could:
- have an opportunity to build wealth more quickly
- benefit from gearing (borrowing money to invest)
- risk losing your entire property if you can’t meet loan repayments.
You can access your equity by borrowing against the value of your home. This may enable you to buy an investment property sooner than if you had to wait to save the money needed.
If your investment produces taxable income, like rental income, the expenses related to owning the investment (including loan interest charges) are generally tax deductible.
In addition, your investment could increase in value over time, and the increase in value may also be taxable. A positively geared investment effectively pays for itself and may generate income, although extra income usually means you’ll pay more tax.
It’s important to consider the risks involved before you release your equity to invest. When you borrow against the equity in your property your overall debt levels also increase. This means you’ll have more financial responsibility, and could lose your property if you were unable to meet loan repayments. Changes in interest rates could also alter the level of risk you’re exposed to. It is recommended that you seek help from an accountant.
The term ‘gearing’ simply means borrowing money to invest. An investment can be negatively, neutrally or positively geared. It all depends on the relationship between the costs of owning the investment, and the income it generates.
|Negative gearing *||Neutral gearing *||Positive gearing *|
|What is it?||The interest payments and other investment costs are higher than the income you receive from the investment.||When the interest payments and other investment costs are equal to the income you receive from the investment.||When the interest payments and the other investment costs are lower than the income you receive from the investment.|
|How can it affect my tax obligations?||You might be able to claim a tax deduction for the interest and investment costs, and reduce the overall tax you pay on your other income||You might be able to claim a tax deduction for the interest and investment costs against your investment income. You won’t be able to reduce the tax you pay on your other income.||You might be able to claim a tax deduction for the interest and investment costs against your investment income. Your income will be subject to tax, but you can use the surplus income to reduce your loan.|
* If your investment earns taxable income, such as rent, you will generally be able to deduct costs, including council rates, insurance, repairs and maintenance. If you’ve borrowed money specifically to buy an investment which earns taxable income, you will generally be able to deduct interest costs. Special apportionment rules apply to investment assets that are also enjoyed privately.
This is our general understanding of current legislation and rules as they apply to individual taxpayers. If you own an investment property through a company or trust, the tax implications may differ.
Taxation laws and their interpretation may change from time to time. We recommend that you consult your tax Adviser for advice on your personal situation and before implementing a gearing strategy.
Things to think about before you borrow to invest
It’s important to be clear about your intentions when you think about investing, particularly if you plan to borrow money to do so. For instance you might be:
- Borrowing to invest in property as part of a long-term savings plan, hoping to earn sufficient rental income to pay off loans and provide an income stream in retirement.
- Buying in a growth area and hoping to sell to make a nice capital gain in a few years’ time.
- Borrowing to develop property to supplement your salary.
- Buying in a holiday spot, intending to earn some rental income to help with the mortgage.
Each scenario has different implications under current tax law, both in terms of deducting interest and investment costs and paying tax on capital gains.
Tax law is complex and changes over time. Uncertainty about future tax changes shouldn’t stop you from putting a well though-out investment strategy in place. It’s just common sense to understand potential impacts and to make sure you’re ready to deal with them before you borrow money to invest.
In addition, you may sleep easier if you pay tax on a positively geared investment, rather than having to worry about cash-flow if you’re negatively geared.
If you decide you want to save a bit more before you invest, an Adviser can help you set saving goals, and find the right loan for you when you’re ready.
Paying off your property sooner
Understanding exactly what you’re paying and when, is the first step to taking control of your home loan. Once you understand how your home loan works you can start looking for ways to pay off your property sooner, such as:
- increase your repayments
- make more frequent repayments
- take advantage of low interest rates
- link to savings in an offset account to reduce the amount of interest payable
- consolidate your debt.