Capital Ideas - Independent Financial Advisors
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Capital Ideas is a trading style of Financial Horizons Ltd which is authorised and regulated by the Financial Conduct Authority, FCA reference No 587075.  Registered in England, company No 07714109.  Registered office 77 Woodcrest Road Darlington DL3 8EE


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Borrowing to Invest (Gearing)

Example 1 – non-geared (no borrowing) – 20% rise in value


Investment                                      £100,000

Property bought for                        £100,000

Rises in value to                            £120,000

Net gain                                           £20,000


Example 2 – geared - 20% rise in value


Investment                                      £100,000

Borrowing                                       £100,000

Property bought for                        £200,000

Rises in value to                            £240,000

Net gain                                           £40,000


So the gain is multiplied because of the borrowing.  Remember, though, that out of any gain you need to pay interest on the loan.


Example 3 – non-geared – 20% fall in value


Investment                                      £100,000

Property bought for                        £100,000

Falls in value to                              £80,000

Net LOSS                                        £20,000


Example 4 – geared - 20% fall in value


Investment                                      £100,000

Borrowing                                       £100,000

Property bought for                        £200,000

Falls in value to                              £160,000

Net LOSS                                        £40,000


So the LOSS is multiplied because of the borrowing.  Remember also that you need to pay interest on the loan, which is a further loss.


Example 5 – highly geared (heavy borrowing) – 30% fall in value


Investment                                      £50,000

Borrowing                                       £200,000

Property bought for                        £250,000

Falls in value to                              £175,000

Net LOSS                                        £75,000


Now there is insufficient to repay the borrowing, AND the loan interest has to be paid


This last example helps to illustrate clearly the possible negative effects of gearing.  If a non-geared investment of £50,000 had been made, a 30% fall in value would have resulted in a loss of £15,000, but there would still be value of £35,000 remaining.  By gearing, the losses were multiplied to the extent that the entire investment was lost, and a debt was created.

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