Debt Recycling – What is it and How Can it Help?

There may be an interesting way to pay down your mortgage faster while gaining a portfolio of assets that create even more wealth. Does this sound too good to be true? The whole objective of debt recycling is to take your home loan from being a non-deductible loan into a tax deductible investment loan. While this strategy can be a great income producer and tax reducer, there are risks and provisos that you need to know before you take the investing path less travelled.

How does debt recycling work?

Debt recycling starts with your home equity. You take the amount that is the difference between your home’s value and what you still owe on your home loan and use it to invest in assets that produce more income. The most obvious income-producing asset is shares or an investment property, but there are a number of assets you could consider. Any income that these assets give can be used to pay down your mortgage faster.

There is also a tax deduction on investment home loans, to earn you more savings towards paying down your home. 1 The idea with debt recycling is that the original mortgage amount will shrink, while your investment loan grows, until you are simply left with a tax deductible investment loan. This is the general idea of debt recycling, but your financial adviser will be able to walk you through the finer details according to your own individual situation.

What are the potential advantages of debt recycling?

• You could pay down your mortgage faster, and even bring in extra income on top of that.
• The more you have paid down your home loan, the more equity you may find yourself with, meaning more investment opportunities.
• Giving yourself the opportunity to diversify your investments is always a good thing.
• The tax savings due to the nature of the investment loan is worth weighing up for your own scenario.
• Debt recycling is more tax efficient than just investing the same amount of cash. With debt recycling, you save the tax you would have paid on the income from your investment, without needing to sequence it through a loan first.

Some downsides to debt recycling

• It is quite complicated in contrast to a regular home loan and you will already need to have a handle on your finances to be able to take on this approach.
• Even though it may be an effective strategy, debt recycling is a risky one, as you are borrowing to invest.
• You will need to keep in mind and discuss the possibility of interest rates rising and investment income being irregular and waiver from time to time.
• Investments do not automatically provide a steady income to rely on, and if the market takes a turn and your investment income drops, you will still be expected to service your loan.
• If you do consider debt recycling, then it is wise to take into account and budget for possible interest rate rises in the future, if you have a variable home loan.
• Strategies like debt recycling do not replace having a solid budget and foundational savings and managing your budget.

How to do debt recycling, in practice

Here is an example debt recycling strategy to give you an idea of how you consider implementing it for your own situation.

• You might have a family home worth $600,000 with a $300,000 loan. You also have $100,000 in your offset account.
• You can cut up your home loan in two so that you now have a $200,000 loan and a $100,000 loan.
• You can pay off the $100,000 loan with the money in your offset account. You can then take it back out, and send it straight to your shares* account. This makes the interest on this loan now tax deductible, as long as the shares are income-producing.

Debt recycling, while effective, may not be a great blanket strategy for everyone. That being said, if you think debt recycling is worth considering for your financial strategy, have a chat with your financial advisor who is well-versed on tax, to be certain that you are implementing it correctly. Debt recycling can be an effective way to reduce a loan and increase your investments, but effective does not always mean better. There is a lot to say for simple savings and budgeting to focus on paying down your home loan as quickly as you can, so you can look forward to a better financial tomorrow. To speak to an adviser about your financial future, call Elliot Watson today on (02) 4038 1623.

To speak to one of our financial advisers regarding debt recycling, make an appointment today on 02 4038 1623 or complete our contact form now.

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, having regard to your own 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 licensee’s position and are not to be attributed to the licensee. They cannot be reproduced in any form without the express written consent of the author. 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.