Borrowing to invest

Borrowing money to invest can increase returns but it can also increase risk. Interest must be paid

on the borrowed money, but this can be offset by the income of the investment. If there is a net

loss at the end of the financial year, then negative gearing $($i$.$e$.$ borrowing$)$ has occurred. This net

loss can be used to reduce the amount of tax paid on other income, such as salary or other business

income.

Imagine that you take out a loan of $$300000$ to add to your own savings of $$200000$ so that

you can spend $$500000$ on the investment property discussed on page $124.$ In summary:

The property is expected to grow in value by $10\%$ p$.$a$.$

Your $$300000$ loan is interest only at $7\%$ p$.$a$.,$ meaning that only interest is paid back each

year and the balance remains the same.

Property costs are $$4000$ p$.$a$.$

Rental income is $$1200$ per month.

Your income tax rate is $30\%.$

a Find the amount of interest that must be paid on the loan each year.

b Find the net cash loss for the property per year. Include property costs, rent and loan interest.

c This loss reduces other income, so with a tax rate of $30\%$ this loss is reduced by $30\%.$ Now

calculate the overall net loss, including this tax benefit.

d Now calculate the final net gain of the property investment for the following number of years.

You will need to find the value of the appreciating asset $($which is initially $$470000)$ and

subtract the net loss for each year from part c above.

i $1$ year

ii $5$ years

iii $20$ years

You now know how millions of people try to become wealthy using compounding investment

returns with a little help from the taxman!