Forums / Property Investing / General Property / The better of two evils; Negative gearing or Cross collateralization

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  • Profile photo of C2C2
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    @c2
    Join Date: 2002
    Post Count: 518

    Which one is the better of two evils if you had to choose to secure the deal?Cross collateralization or Negative gearing?Why is one better than the other for a last resort?

    Profile photo of elkamelkam
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    @elkam
    Join Date: 2006
    Post Count: 722

    Hello C2

    Very simply

    Cross collateralizing is when you offer more than one property as collateral for a mortgage. This is usually done to avoid paying LMI. The banks love it but most investors don't as it's messier and can be more expensive if you want to sell one of the properties.

    Negative gearing is when the expenses for a property exceed it's income. This loss can be deducted from your other income and is more helpful for people paying tax in the higher brackets. This reduction in tax is a help in financing the holding costs of the property while it appreciates. Expectation of good capital gains is the justification for negative gearing.

    A bit confused about your question as the two are not an either/or option for me.
    Does your question relate to a specific situation ?

    Cheers
    Elka

    Profile photo of ducksterduckster
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    Join Date: 2004
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    As Elka stated "Does your question relate to a specific situation ?"
    Possible situations .

    Situation one:
    You have a property with heaps of equity but you do not have any cash for a deposit for the next property purchase.
    Solution one.:
                 Borrow money from house one as line of credit and avoid cross colaterisation.
    Pros – You now have money for deposit. on second house. The First house doesn't become repossessed if you can't pay loan on
                 house two.
    Cons. You have borrowed the deposit so you have to pay interest on the first line of credit loan as well as the new investment
                loan. So you are probably negatively geared anyway.
    Solution Two.
                Use property one as security as well as property two.

    Pros- Avoid Loan Mortgage Insurance. If you get behind in repayments you have breathing space due to lower Loan value ratio.
               May make it easier to borrow from bank.
    Cons. Will probably be negative geared. If you default you could lose both houses.



    Situation two:

    You have heaps of cash lying about for a deposit for the next property purchase.
    Solution one.:
                 Use cash as a deposit for investment property and lower LVR thus making property positively geared..
    Pros – You earn an passive income.Property doesn't cost you money to hold.
    Cons. You have to pay income tax on positive property income . You are not using maximum gearing.
    Solution Two.
                Use cash to pay down property one which is probably a main residence and interest payments are not tax deductible.
                Borrow using both this property and investment property as security for loan two.

    Pros- You main residence or PPOR has less non tax deductible interest payments. Avoid Loan Mortgage Insurance. If you get behind in repayments you have breathing space due to lower Loan value ratio. May make it easier to borrow from bank. Maximum leverage.      
    Cons. Will probably be negative geared and can claim a tax deduction to help pay off loan. If you default you could lose both houses.  

    Profile photo of freelancefreelance
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    @freelance
    Join Date: 2008
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    Hi Duckster,

    In regards to the pro's and con's in solution two…

    What's the difference between a positive cash flow property and a maximum geared property?

    Cheers

    Profile photo of elkamelkam
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    @elkam
    Join Date: 2006
    Post Count: 722

    Nice detailed post Duckster.

    If you are in situation 2 ( lots of cash for a deposit ) and have a mortgage on your PPOR ( non deductible interest payments ) then the best solution is to use the cash to reduce your PPOR mortgage and then go to situation 1 solution 1. ( establish line of credit against PPOR and use this as deposit and avoid cross collateralization ).

    Though your total interest bill remains about the same you now have less non tax deductible interest and more tax deductible interest.

    If you search the forum you will find better explanations of this from some of the cluey brokers on the forum. 

    Cheers
    Elka

    Profile photo of C2C2
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    @c2
    Join Date: 2002
    Post Count: 518

    Elkam,

    I know what each one is, how they work etc and have no particular situation in mind.

    Was basically just wondering what people think of both and which one is the lesser of two evils.

    After reading a few posts lately and seeing how some people had ended up using one or the other, the question was aimed more to provide information for others to see on the  pros and cons as set out as in Ducksters post.

    If the only way to secure a deal is one of the two options then which one could be considered the better option.

    For me if the only way to seal the deal was to cross or neg then I would choose cross mainly because it is better to be taxed on a profit  rather than be negative geared. 

    Profile photo of ducksterduckster
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    @duckster
    Join Date: 2004
    Post Count: 1,674

    A maximum geared property has less of your cash in it and more borrowed money in it. So you could have another property that is non tax deductible having less borrowings against it while having the deductible property having more borrowings and less deposit through cross co laterilising it.

    Alternatively you may have one property that is positively geared and another property that is negatively geared. The two balance out so that you are offsetting positive passive income against a rental loss property so nett property income = zero.

    positively geared property could have a larger deposit and smaller loan thus making it positively geared assuming that it is difficult to get positively geared property without a large deposit in the current property market.

    c2 "Was basically just wondering what people think of both and which one is the lesser of two evils."
    Negative gearing!
    It really depends on if you can afford to cover the short fall if negatively geared.
    How many properties can you afford to cover with your wage.
    You are betting on capital growth after capital gains tax is taken out to outstrip the costs of holding the property.
     If interest rates go up your costs go up.

    Positive gearing.
    If you are like me with no wage – cash flow is more important.
    You own less property but it doesn't cost you to keep properties.
    Pay less land tax as you own less properties
    If you keep paying down properties and buying more eventually you have cash flow that can be used to cover a negatively geared property. So you can eventually have a mix of both methods.

    I use to be negatively geared but am now positively geared.

    Profile photo of TerrywTerryw
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    @terryw
    Join Date: 2001
    Post Count: 16,190

    Hi C2

    What makes you think negative gearing is evil? I had a negative geared property increase in value by $600,000 in just a few years. Doesn't sound evil to me!

    Terryw | Structuring Lawyers / Loan Structuring Pty Ltd
    http://propertytaxbook.com.au/
    Email Me

    Lawyer, Mortgage Broker and Tax Advisor (Aust wide) http://propertytaxbook.com.au/

    Profile photo of elkamelkam
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    @elkam
    Join Date: 2006
    Post Count: 722

    Whether a property is cross collateralized or not does not effect it's being negatively or positively geared.

    As duckster posted, if you have a large cash deposit then the property is more likely to be positively geared. With a large deposit why would you have your loan cross collateralized. 

    On the other hand cross collateralizing a property does not make it positively geared. You still owe the bank the same amount of money in relation to that property and therefore the interest bill ( usually the largest holding expense ) is the same. Cross col. just means that the loan is secured by more than one property.

    Whether it is positively or negatively geared is dependent on the income the property generates.

    Sorry, not trying to be argumentative here. 
    Elka 

     
     

    Profile photo of C2C2
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    @c2
    Join Date: 2002
    Post Count: 518

    Duck, Elk,

    Good to get some balanced feed back to the question.

    A cross property could be neg or pos geared and a neg property could be crossed or on its on.

    Terry,

    Just a generalization on neg that's all.

    Neg geared with exceptional CG is still a good deal.

    There are a quite a few comments from members not able to find pos CF properties and some of them would be considering properties that they may need to cross or neg to obtain.  This forum does tend to advise members not to cross or neg but sometimes it can't be helped especially if the deal is still good.

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