What is Debt Recycling?

More Australians are using debt recycling to pay off personal loans or home loans that aren’t tax-deductible, while also growing their investments.

But how does debt recycling work? And is it for you? Let’s break it down.

What Is Debt Recycling?

Debt recycling is a financial strategy that involves using the equity in your home to invest in income-producing assets.

You basically replace non-deductible home loan debt with tax-deductible investment debt. This approach aims to reduce your mortgage faster while you build an investment portfolio.

Let’s unpack this:

Non-deductible debt: This is debt on which you can’t claim tax deductions, your typical owner-occupier home loan.

Deductible debt: Debt used for income-generating investments, like shares or an investment property. Interest on this kind of debt can usually be claimed as a tax deduction. ​

How Does Debt Recycling Work

You can use debt recycling as follows:

Pay Extra Into Your Home Loan

You begin by making additional repayments on your home loan. These can come from:

• Surplus income (e.g., from your salary)

• Bonuses or tax returns

• Existing savings

Every dollar you pay off reduces the principal (the amount you owe). If your home loan has a redraw facility or is a loan with an offset account, that extra money becomes available for you to access again, if necessary.

Redraw or Re-Borrow the Paid-Off Amount

Once you’ve made extra repayments, you can then redraw that money from your home loan, or re-borrow it (depending on your loan structure). You’ll have one loan account for your personal (non-deductible) mortgage, and another for your investment (deductible) portion.

Invest The Re-Borrowed Money

The redrawn funds are then used to invest in income-generating assets, such as shares, managed funds, and investment properties.

Use Investment Income To Repay Your Home Loan Faster

Any income earned from your investments is used to make extra repayments on your home loan (the non-deductible portion).

This creates a loop:

• Extra income reduces your mortgage.
• You redraw that amount again.
• You reinvest.
• The new investments generate income.
• Repeat.

Repeat The Cycle To Transform Your Debt

When you repeat this cycle, over time:

• Your home loan principal shrinks.

• Your investment loan grows.

• Your total debt remains similar, but it’s increasingly tax-deductible.

• Your investment portfolio grows in size and value.

Eventually, you could:

• Fully pay off your non-deductible home loan, and

• Hold a well-performing investment portfolio supported by tax-deductible debt.

Copy HTML to Clipboard

Debt Recycling Example

Let’s look at an example. Meet Sarah.

• She has a $400,000 owner-occupier mortgage.

• She earns well and pays an extra $20,000 off her home loan.

• Her principal drops to $380,000.

Now:

• She redraws the $20,000 and invests it into a diversified share portfolio.

• The portfolio earns $1200 a year in dividends.

• Sarah uses the $1200 to make more extra repayments on her home loan.

She repeats this cycle annually. Each year:

• Her non-deductible mortgage drops.

• Her investment loan (used to buy shares) grows.

• She claims the interest on her investment loan as a tax deduction.

• Her share portfolio keeps compounding.

In 10-15 years, she may:

• Have a paid-off home loan, and

• Own a six-figure (or larger) investment portfolio.

Build Wealth And Lower Your Mortgage At The Same Time!

Debt recycling can help you pay off your home loan quicker while building your financial future.

Learn More

Requirements For Debt Recycling

For effective debt recycling, you need:

• Home loan with existing home equity

• Regular income to cover investment loan interest

• Long-term investment mindset

• Willingness to increase debt and maintain an investment loan

• Risk tolerance for short-term investment fluctuations

• Income protection insurance (to provide replacement income when you can’t work)

Benefits Of Debt Recycling

If you’re thinking about debt recycling, it’s important to understand how it could help you manage your finances and build wealth over time.

While it might sound complicated, the idea is to make your money work smarter for you. Here are some key benefits:

Tax Savings

When you borrow money for investing, the interest you pay on this loan can be claimed as a tax deduction, which means you could pay less tax, and keep more of your hard-earned money.

Faster Mortgage Payoff

When you use investment income to make extra payments on your home loan, you can pay off your mortgage sooner. This saves you thousands in interest and gives you freedom to own your home faster.

Building Wealth Over Time

Debt recycling helps you build an investment portfolio, which can generate income and increase in value. This ensures you build a stronger financial future. So, you don’t have to just focus on paying off your debt.

Improved Cashflow Management

With a clear plan, debt recycling encourages disciplined money management. It helps you focus on reducing non-deductible debt while creating new income streams, which can improve your overall financial health.

Greater Financial Flexibility

As your investments grow and your home loan shrinks, you may find yourself with more options to manage unexpected expenses or pursue new opportunities.

Risks Associated With Debt Recycling

Debt recycling is risky, since you are borrowing money to invest, using your home as security. If your investments don’t do well or interest rates go up, it could cause serious financial stress, even putting your home at risk.

So, before you dive head first into debt recycling, keep the following things in mind:

• Borrowing to invest can boost gains when markets rise, but losses can be bigger if markets fall – and you still have to pay the loan interest.

• If your loan has a variable interest rate, repayments could increase, which might strain your cashflow, especially if your investment income drops.

• Investments bought with borrowed money can lose value, too, meaning you might owe more than the asset is worth even after selling it.

• It takes discipline to use your investment income and tax savings to pay down your home loan instead of spending it.

• If you go ahead, check your insurance to make sure the extra loan can be covered if something unexpected happens.

Is Debt Recycling Right For You?

Debt recycling is a sound financial strategy. But only if it suits your goals and risk tolerance. Here are two scenarios to better understand its fit for you:

Scenario 1 – When It Is Right

You may opt for debt recycling if:

• You have a stable income and can make regular loan and investment repayments.

• You are already making extra mortgage payments.

• You have a long-term outlook and market fluctuations aren’t a factor for you.

• You are in a higher tax bracket and want to take advantage of tax deductions.

• You are financially disciplined and open to help from a financial adviser.

Scenario 2 – When It Is Not Right

Debt recycling may not be suitable for you if:

• Your income is unstable or irregular.

• You are anxious about taking on more debt.

• You have high-interest consumer debts (like credit cards).

• You are nearing retirement.

• You are not financially disciplined and prefer simple strategies.

Final Words

Debt recycling allows you to convert non-deductible home loan debt into tax-deductible investment debt. With it, you can accelerate your mortgage repayments and build wealth on the side.

And while debt recycling can help you save taxes, pay off your mortgage faster, and build wealth, it also carries risks, especially if the market becomes volatile. So, it is not a smart option if your income is unstable, you have a low risk appetite, or are nearing retirement.

But if you are down, discuss your options with one of our mortgage brokers today. Enquire online or call us on 1300 889 743.