Negative Gearing is Not the Answer For Low to Medium Income Earners – Three Reasons Why You Must Invest in Cash Flow Positive Property If You Are On A Low to Medium Income
You’ve probably heard a lot about negative gearing and how it can save you money on your taxes. However, there are many reasons why it’s not the best investment strategy for some investors.
Investors often disagree about the best strategy to use for their purchases.
Some will argue that your investment needs to make money for you from the moment you buy it.
Others will point you towards negative gearing. With this strategy, your goal is to maintain a property for which the income is lower than the expenses. You will then use this disparity to claim back tax money.
It sounds good in theory.
However, there are a few big problems with negative gearing that makes it only suitable for those who have plenty of spare cash.
Lots of our high income earning Members use it because they are paying $60,000++ in income tax every year.
We’ll get into the reasons why negative gearing isn’t right for you in a moment. But first, let’s take a look at what your cash flow situation might look like with this strategy.
Why Negative Gearing Doesn’t Work For New Investors
The key problem with negative gearing is that the strategy takes money out of your own pocket.
Yes, you do get to claim some of your losses back on your taxes. However, this is also something that only occurs every 12 months. You also need to account for what’s happening month-on-month with this strategy.
And the simple fact is that under this strategy, you have to spend your own money to maintain the property.
However, some will tell you that the tax benefits outweigh the strategy’s disadvantages.
What you should know is that it is not always the case.
Take a look at this chart to get a better picture:
Here we see a comparison between two investors. One invests via a positive cash flow strategy, while the other invests using a negative gearing strategy.
We can see that the positive gearing strategy leads to a higher tax bill. However, we can also see that the large taxable income, combined with lower interest payments, counteracts the tax bill.
That’s a key point.
But what this chart shows us is that the amount claimed doesn’t measure up to the extra earnings from a positive cash flow strategy.
That alone is a compelling reason to ditch negative gearing and go for a positive cash flow. However, there are several more compelling reasons that you need to consider.
Reason #1 – The Immediate Ability to Cover Your Property’s Costs
Let’s imagine that you’ve just bought your first investment property. And better yet, you’ve managed to find a tenant in short order. That means the property’s immediately generating revenue for you.
Of course, you also have a mortgage on the property. This means that it’s costing you a certain amount each month to hold and maintain.
Now, imagine that you get past your first or second month and you find that the income doesn’t cover the costs. You have to pay out of your own pocket for the mortgage and any maintenance costs.
If you have access to a lot of cash, that may not be a problem. However, most new investors have to scrimp and save just to afford their first property in the first place.
Having to spend more each month just to keep it is not an ideal situation and adds more burden to you.
But with a positive cash flow strategy, your property starts generating a profit from day one. That means you don’t have to worry about impacting your own quality of life just to start investing.
Speaking of which…
Reason #2 – You Actually Get an Income (Which Increases Over Time)
At the end of the day, you invest in property so that you can generate a passive income. The goal is to build a portfolio that’s large enough to provide for you and your family.
And if you invest well, that portfolio will also increase in value, which gives you the option to sell it in the future for more profit if you want.
You don’t get this income with a negative gearing strategy.
Instead, you get to spend money from other income sources just to hold the property. And as the chart above shows, the tax benefits that you gain do not outweigh the income that you’ll lose.
This is especially true if you take out an interest-only mortgage to “capitalise” on the tax benefits.
The positive cash flow strategy means that you make a profit from the moment that you have a tenant in your property. You can then use the profit you generate to improve your life.
Reason #3 – You Can Afford to Service Future Purchases
It’s likely that you’ve been through the home loan approval process when buying your own home.
This means that you know that lenders want to see that you have a stable income. The lower your income, the less able they believe you are to pay off your loan.
Now, think about what happens with a negative gearing strategy.
You’re actively putting a dent in your income in order to benefit later. However, lenders won’t care about the potential tax savings. They’ll simply see a low monthly income and look at you as a risky customer.
This means you may not be able to borrow the money that you need for future purchases.
And of course, this slows down your attempts to build a portfolio.
But if you can show lenders that your current investments do generate an income, they’re more likely to approve your application.
Avoid the Negative Gearing If You Are On A Low to Medium Income
We’re not saying that negative gearing never works. It works great for high income earners.
However, it’s a strategy that’s best left to those who already have a sizeable income. This income needs to be large enough to cover their losses and keep them serviceable as they wait for the tax benefits each year.
Most new investors aren’t in that position just yet.
It’s much more likely that a positive cash flow strategy will suit your needs. But of course, that means you also need to know how to find the properties that generate an income.
Oh and by the way, at Freedom we have properties that are positive cashflow WITHOUT tax deductions but the property STILL QUALIFIES for a tax deduction. You need to talk to us to find out more exactly how we do this.
That’s where Freedom Property Investors come in.
We can help you find the perfect property for a positive cash flow strategy. To find out how, get in touch with our team today.