Is gearing good or bad?
People often ask us ‘is gearing good or bad?’
Here it is…
Understand (and use) the power of gearing.
What is gearing?
Gearing is essentially using or leveraging other people’s money to get ahead.
Used carefully and wisely, borrowing money can ‘turbocharge’ returns on an investment. Used incorrectly and in the wrong market conditions, it can be disastrous. Particularly, if you haven’t taken steps to reduce the risks.
With other people’s money, you can increase the value of the total pool of investments that your returns are generated on by putting down a smaller deposit and borrowing the money from someone else—normally a bank.
The key point
The key is to make sure the total return (income and growth) is greater than the cost of borrowing. This chart illustrates the power of using other people’s money.
If you are still wondering if gearing is good or bad
Above all, with any investment there is risk. When you rely on other people’s money to increase your return on investment, there’s a risk. However, when you manage the risk responsibly and carefully, you can benefit from using the power of gearing.
Ways to reduce risk
A higher quality income source, or multiple sources of income, are often considered to be ways that you can reduce the risk of continuity of your income on any investment. Therefore, having 2 cheaper properties rather than 1 expensive one, means that if one of your tenants is unable to pay the rent, then hopefully you will still receive rent from the other property.
Likewise, there a number of methods to reduce the risk of gearing, but one of the simplest ways is by fixing your interest rate. By capping the maximum amount of interest you’ll pay, you are reducing the risk that your costs will exceed your income.
Investopedia publish a guide to gearing ratios too.
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