How negative gearing actually works and whether interest‑only repayments make sense

Negative gearing is simply a situation where the costs of owning an investment property – mainly loan interest, plus things like rates, insurance and depreciation – are more than the rent it brings in. That shortfall, or loss, can be offset against your other income (such as your salary) in the same financial year, which may reduce your overall taxable income and the tax you pay.

How much tax you save depends entirely on your marginal tax rate and the size of the loss. If you’re on the 37% marginal rate and your property makes a $10,000 loss for the year, you might see around $3,700 less tax. The actual cash‑flow benefit is smaller – you’re still out of pocket by the net loss after tax.

The single biggest cost in most negatively geared properties is loan interest, and that’s where the choice between interest‑only and principal‑and‑interest repayments comes in.

Interest‑only repayments and your tax position

With an interest‑only loan you pay only the interest on the amount borrowed for a set period, so your repayments are lower during that time. For an investor, the full interest payment is generally deductible while the property is rented or genuinely available for rent, which can maximise the loss you report and the tax deduction you receive in the short term.

Once the interest‑only period ends, the loan automatically becomes a principal‑and‑interest loan. Your repayments will rise because you now have to start paying down the loan itself on top of the interest. On a typical loan, the jump can be significant – a change of several hundred dollars a month is not unusual.

The numbers are important. As an illustration published by Moneysmart, someone borrowing $500,000 over 25 years with an initial five‑year interest‑only term could see monthly repayments rise from about $2,010 to around $3,250 when the interest‑only period ends (based on a comparison rate of 4.8%). That’s a substantial lift that needs to be budgeted for.

A principal‑and‑interest loan from day one would give a steady repayment, which in that example was around $2,875 a month. The interest‑only path temporarily frees up cash, but you pay nothing off the debt during the interest‑only years and you eventually face larger repayments later.

Weighing the trade‑offs

On the plus side, lower interest‑only repayments can help you direct cash elsewhere – perhaps to pay down other more expensive debt or to cover holding costs while waiting for rent to grow. The tax deduction will also be larger in the early years because no principal is being reduced, potentially enlarging the annual loss you can claim.

On the other hand, if your property doesn’t rise in value during the interest‑only period you won’t build any equity through debt reduction. That can leave you exposed if the market turns or your circumstances change and you need to sell. Moneysmart also notes that interest‑only loans can carry a higher interest rate than principal‑and‑interest loans, meaning you pay more interest over the life of the loan.

Broadening the picture: depreciation and capital gains

The ATO explains that deductions for rental properties can include more than just loan interest – you can generally claim depreciation on the building structure and plant and equipment, as well as costs like council rates, insurance and property management fees. These non‑cash deductions can increase the assessable loss without further out‑of‑pocket spending, potentially improving the tax outcome.

When it comes to capital gains tax (CGT) down the track, any gain you make when you sell will be calculated on the sale price less your cost base. The cost base includes the purchase price plus certain holding costs (but only those that haven’t already been claimed as a deduction). So while negative gearing can help with cash flow year to year, the eventual CGT position is a separate calculation that’s worth keeping in mind from the start.

How Arrivau fits in

Arrivau Pty Ltd provides credit assistance as a licensed Australian mortgage broker under its Australian Credit Licence. We can help you compare loan products and structures – including interest‑only and principal‑and‑interest options – so you can understand what the repayments and features might look like for your situation.

Arrivau is not a lender and does not promise loan approval, specific interest rates, savings or any financial outcomes. The information we provide is general in nature and does not constitute personal financial advice. We recommend you speak with a qualified tax professional about the deductibility of interest, depreciation schedules and any CGT implications before making a decision.

Arrivau does not claim to be an insurer or underwriter.