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Gearing mainly used for Property
The most common form of gearing is borrowing to invest in property such as the family home, or rental investment properties. Gearing can also be used for other investments, including the purchase of shares or managed funds etc.

If you borrow 50% of the money to purchase an asset, then that asset is said to be 50% geared. If you borrow the full amount necessary to purchase an asset or investment, then the asset or investment is said to be fully geared.

If you use some of your own money, as well as borrowed money, then the investments are partly geared. Gearing helps to increase the gain or the loss of an investment.

For example, if you have $10,000 invested in an asset and it increases in value by 10% the gain will be $1,000. But if you had borrowed $20,000, added that to your $10,000 then invested the total of $30,000, the 10% gain would have been $3,000.

The gain comes about if the 10% gain is higher than the percentage interest you have to pay on the gearing. That gain could be a capital gain due to increase of property values and if you carry out gearing properly it should result in a profit for you.


How Gearing Works
For the average person, wealth can only be achieved by 'gearing'.

To 'gear' something in the technical sense, means to use a small effort to move a large object, thereby gaining a mechanical advantage (e.g. a bicycle with gears).

Likewise, by using a crowbar, you only need a small effort to lift or lever a large load.


Example: Crowbar Leverage



In a financial sense, gearing of assets (or leverage as it is known in the the USA) has a similar effect. A small amount of money can control a large asset – using the crowbar of the financial industry – a loan.

The higher you are geared, the more money borrowed – equals – the greater the financial gains.

The formula as far as property is concerned, is:-

Gearing (or Leverage) of Property =
Asset Value
Deposit (Equity

Property Gearing Ratios

Property Measuring Gearing Ratios
 
 
No Gearing
Gearing
Asset Value
$140,000
$700,000
Deposit (Equity)
$140,000
$140,000
Loan
$0
$560,000
 
Gearing Ratio
1
5

If you think of the loan of $560,000 as a lever, then the chart below shows how a deposit of just $140,000 enables you to control 5 properties with a total value of $700,000.


Loan Leverage

5 x $ 140,000 = $700,000

A deposit of $140,000 plus a loan of
$560,000 gives you to leverage to own and control 5 properties worth $700,000.

Deposit $140,000 + LOAN = $560,000 = $700,000

'Gearing' works in the property investor's favour because as the property grows in value, gearing magnifies the gain further.