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Consider The Negative Of Home Buying

Oct 13, 2007
Buying a first home or unit as an investment could be a better financial proposition than buying a house to live in, particularly if you and/or your partner pay income tax at a relatively high marginal rate.

As an investor, you will be able to take full advantage of the negative gearing provisions of the tax law. Negative gearing involves claiming a tax deduction against taxable income for the interest and other expenses which exceed the income from a rental real estate investment.

As an investor, you will have to rent a house or unit to live in while buying an investment home. But the combined exercise of buying an investment house or unit while you rent, or live free of rent at home, can be a more attractive financial proposition than buying an owner/occupied home.

Much depends on the rent you have to pay because - as with any owner/occupied house mortgage - it comes from after-tax income. A good rule of thumb is to consider negatively gearing an investment house only when the cost of servicing the home mortgage and associated home ownership costs (insurance, rates, repairs etc) exceeds the rent you are paying by a substantial margin.

Consider an example of a young couple both earning $25,000 a year currently renting for $200 a week. The couple has a $30,000 deposit to put on a unit costing $130,000 (including fees and charges).

Buying the unit involves borrowing $100,000 to fund the purchase. Taking the worst-case scenario, the couple will have to pay 14 per cent interest on an investment loan. As owner/occupiers, they could obtain an owner-occupied loan at an interest rate of 12.5 per cent.

Owner/occupation would involve costs of about $300 a week made up of about $250 a week interest costs on the loan at the 12.5 per cent rate and another $50 a week expenses of owner/occupation.

Continuing to rent while buying an investment unit means paying $200 a week in rent plus the negative gearing loss. Assuming that the unit bought can also be rented out at $200 a week, the negatively geared unit would involve total costs of about $330 a week (allowing for the higher 14 per cent interest rate on the investment loan) and provide a weekly income of $200 a week.

The loss on the investment for tax purposes would be $130 a week. The couple pays tax at a marginal rate of 39.25 per cent (for all income above $20,000) so the tax loss would generate a tax refund of 39.25 per cent.

The after-tax cost of buying an investment while still renting would be $79 a week (a $130 loss minus a $51 tax saving). This is $21 a week lower than the $100 a week additional costs involved with owner-occupation.

The financial advantage of negative gearing increases with the taxpayer's marginal tax rate. For example, taxpayers with a taxable income above $36,000 a year receive a tax deduction at a 47.25 per cent rate compared with the 39.25 per cent rate used in this example.

Somewhat paradoxically, negatively gearing a house or unit involves less financial risk than buying one to occupy. This is because of the tax deduction available for any recurrent losses from the investment.
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