Many Australians choose to buy investment properties as a wealth creation strategy. But it’s important to understand that investment properties can have a positive, neutral or negative effect on your cash flow.
Well-chosen investment properties in desirable locations can potentially build your wealth in two ways:
1) via growth in the value of the property over time.
2) via the rental income they generate.
Investment properties that achieve these goals are an example of good debt.
This is a situation where the rental income from the property exceeds all the expenses associated with it (such as loan interest, rates, repairs and maintenance). The property increases your cash flow overall, though the timing of when its expenses fall is an important factor to consider.
This is where the rental income and the expenses associated with the property are equal (or virtually equal).
This is where the overall expenses associated with the property exceed the rental income it generates. This is known as negative gearing. It’s a strategy you can use to reduce your tax.
The ability to deduct expenses associated with an investment property from your taxable income is a key difference between it and a home loan for the property where you live. The interest on your home loan and any other expenses associated with it are not tax-deductible. That’s one reason why it’s important to pay off your home loan as soon as possible.
It’s also important to understand that tax-deductible expenses associated with an investment property can include items that you don’t actually pay for out of your own pocket. Australia’s income tax laws allow non-cash items to be deducted from investment property rental income, such as depreciation on furniture and appliances.
In addition to obtaining tax benefits, the capital growth of a negatively-geared investment property over time can potentially offset your out-of-pocket costs. But that’s not guaranteed.
Yes, it’s possible to use the equity (level of ownership) that you build up in your home over time as a security deposit on an investment property. Whether this is a good strategy or not depends on your individual financial circumstances and goals.
You build up your equity in your home over time in two ways:
1) as the value of your home/investment property increases.
Although there’s no guarantee of that happening, Australian property prices have a historical long-term growth trend, even though there can be shorter-term periods when values are flat or when they decline in certain property markets.
2) as the amount you owe on your home/investment property mortgage reduces with the repayments you make.
It’s important to understand that it takes time for a mortgage to reduce. In the early years of a typical mortgage, most of your repayments are being absorbed by interest on the amount you borrowed (the principal). Only a small proportion comes off the principal. Over time, more and more of your repayments start reducing your principal, while less is absorbed by interest and the amount you owe gets smaller.
At Fast Repay Home Loan, we can help you to implement strategies to pay off your home loan as soon as possible. We can help you to become debt-free sooner or to build your wealth more quickly by leveraging good debt. We’ll take the time to understand your needs and goals so we can provide you with the best possible advice.