Debt recycling explained: What is it and how can it help?

Debt recycling is a financial strategy that involves using the equity in your home to invest in income-producing assets while gradually converting non-deductible home loan debt into potentially tax-deductible investment debt. In simple terms, it’s about making your existing debt work harder for you—but it comes with risks and conditions to understand before getting started.

Debt recycling at a glance

Purpose: Investing while repaying your home loan builds wealth and improves tax efficiency.
How it works	Potential benefits	Main risks
Build equity in your home.  Redraw or reborrow against that equity.  Invest the borrowed funds in income-producing assets.  Use the investment income (and any tax benefits) to pay down your home loan.  Repeat the process over time.	Accelerates debt reduction and builds an investment portfolio. Can make part of your loan interest tax-deductible (if funds are used for income-producing purposes). May increase long-term wealth and tax efficiency.	Market downturns or lower investment returns. Interest rate rises increase repayments. Cash-flow pressure if income stops. Negative gearing losses are possible if returns are lower than interest costs. Borrowing magnifies both gains and losses.

How does debt recycling work?

Debt recycling starts with the equity in your home—the difference between its current value and what you still owe on your home loan. The process typically involves:

1. Build equity: Over time, you pay down your mortgage, and your property’s value may increase. 
2. Redraw or reborrow: You access some of this available equity by splitting your loan or creating a separate investment loan. 
3. Invest: Borrowed money is used to purchase income-producing assets such as shares, managed funds, or investment properties. 
4. Use returns to repay your home loan: Any investment income or tax savings can be directed towards repaying the non-deductible home loan faster. 
5. Repeat: As equity builds again, you can repeat the cycle—gradually replacing non-deductible debt with deductible investment debt.

Understanding tax deductibility 

Under current Australian tax law and ATO guidelines, interest on borrowed funds is generally tax-deductible only if the money is used to produce assessable income.

For example, if you redraw $100,000 from your home loan and invest it in shares that pay dividends, the interest on that $100,000 portion may be tax-deductible because it’s used for an income-producing purpose.

However, if you use the same funds for personal spending, home renovations, or a holiday, that portion of interest remains non-deductible, as it does not generate assessable income.

Tax benefits depend on your marginal tax rate, investment performance, and personal circumstances. Always seek professional advice to confirm deductibility and compliance with ATO rules.

Example scenario 

Image: Freepik

Imagine a homeowner with a property valued at $800,000 and an outstanding home loan of $400,000. Over time, they pay down $50,000 of the loan and build up equity. They then:

• Split their loan into $350,000 (home loan) and $50,000 (investment loan).
• Reborrow the $50,000 to invest in managed funds.
• The income from these funds and any available tax deductions from the investment loan interest are used to make extra repayments on the home loan.

Over time, the homeowner’s non-deductible home loan may reduce while their deductible investment loan grows, provided the investments perform as expected.

This example is for illustration only—it does not account for market volatility, tax changes, or personal cash-flow needs.

Potential benefits of debt recycling 

When implemented carefully, debt recycling can offer a range of financial benefits for homeowners who have built up equity and want to make their money work harder. By using surplus cash flow and home equity to invest in income-producing assets, you may be able to accelerate debt reduction, grow your investment portfolio, and improve your overall tax efficiency. 

Benefits may include: 

• May accelerate home loan repayment while growing an investment portfolio.
• Can improve long-term tax efficiency if the investment loan interest is tax-deductible.
• Creates an opportunity to build income-producing assets that support financial independence.
• May suit investors with a long-term outlook and stable income.

While the long-term benefits of debt recycling can be meaningful, they depend on one’s personal circumstances, investment performance, and ability to manage the risks involved.

Key risks to consider

Like any financial strategy involving borrowed funds, debt recycling carries several risks that should be carefully understood before starting. While the goal is to convert non-deductible home loan debt into tax-deductible investment debt, the strategy can also amplify losses if investments underperform or interest rates rise. 

The key to making an informed decision is understanding how each risk could affect your cash flow, total debt, and investment returns—and how these factors align with your financial goals and risk tolerance:

• Market risk: Investment returns may fluctuate or fall during downturns.
• Interest rate risk: Rising interest rates can increase repayments.
• Cash-flow risk: If your income stops, loan obligations continue.
• Negative gearing: If investment income is less than interest costs, you may experience ongoing losses.
• Lender limits: Loan-to-value ratios (LVRs) and lender rules may restrict how much you can borrow.

Risk mitigation for your debt recycling strategy

Image: Freepik

Because debt recycling involves borrowing to invest, managing risk is critical to protect your long-term financial goals. Even with a well-designed strategy, market changes, interest rates, or personal circumstances can affect outcomes. 

A sound debt recycling strategy should include safeguards that help you maintain stability through different financial conditions and protect your ability to service your loans. Planning ahead and reviewing your approach regularly with a qualified financial adviser can make the strategy more sustainable and aligned with your risk tolerance.

This includes: 

• Maintaining a cash buffer or emergency fund.
• Diversifying across multiple income-producing assets.
• Keeping income protection insurance to protect against loss of earnings.
• Regularly reviewing your investment portfolio, interest rates, and cash flow with a qualified financial adviser.

Who is debt recycling best suited to?

May suit:	May not suit:
Investors with a long-term horizon (10+ years). Homeowners with stable, reliable income and surplus cash flow. Those who are comfortable with moderate to high risk and investment volatility. Individuals seeking to make their debt more tax-efficient under Australian tax law.	Those with unstable income or low risk tolerance. Homeowners with little equity or high existing debt levels. Anyone who is uncomfortable with borrowing to invest or managing market risk.

If you are in a secure position and feel that debt recycling aligns with your financial goals, there are a few key elements to consider before you start: 

• Ensure you have sufficient equity in your home.
• Confirm your borrowing capacity and lender requirements.
• Make sure you have surplus cash flow to manage repayments.
• Understand the tax implications and seek advice from a qualified financial adviser or tax professional.
• Review your personal insurance and emergency funds to protect against unforeseen events.

Alternatives to debt recycling

Debt recycling can be an effective financial strategy for some homeowners, but it’s not the only way to build wealth or reduce non-deductible debt. 

If you’re uncertain about taking on additional investment debt or want to start with a lower-risk approach, consider simpler and more flexible options. Each alternative has different levels of risk, liquidity, and potential tax benefits, so the best choice depends on your personal goals, cash flow, and comfort with borrowing.

• Making extra repayments directly into your home loan.
• Using an offset account to reduce interest without additional risk.
• Investing surplus cash flow in income-producing assets without borrowing.
• Paying down non-deductible debt before increasing exposure to investment loans.

Key takeaways

Debt recycling can be a valuable part of a long-term financial strategy when used thoughtfully and supported by the right advice. It allows you to use your home equity more effectively, gradually shift from non-deductible to deductible debt, and accelerate wealth creation through investing.

However, this approach isn’t suitable for everyone. Because it involves borrowing to invest, it carries higher risks and requires stable income, discipline, and a clear understanding of the benefits and potential downsides.

Getting tailored guidance from a qualified financial adviser is essential if you’re considering whether a debt recycling strategy fits your goals. The Elliot Watson Financial Planning team can help you assess your financial position, risk tolerance, and long-term objectives to determine whether debt recycling—or an alternative strategy—is the right step toward financial independence.

Contact us at admin@elliotwatson.com.au or call (02) 4038 1623 today!

Disclaimer:

The information within, including tax, does not consider your personal circumstances and is general advice only. It has been prepared without taking into account any of your individual objectives, financial solutions or needs. Before acting on this information, you should consider its appropriateness regarding your objectives, financial situation and needs. You should read the relevant Product Disclosure Statements and seek personal advice from a qualified financial adviser.

The views expressed in this publication are solely those of the author; they are not reflective or indicative of the licensee’s position and are not to be attributed to the licensee. They cannot be reproduced in any form without the author’s express written consent.

Elliot Watson Financial Planning Pty Ltd and its advisers are Authorised Representatives of RI Advice Group Pty Ltd, ABN 23 001 774 125 AFSL 238429.

Feature Image: Freepik