Investors utilise a lot of different methods when it comes to growing wealth. In this article we explore what debt recycling is, how it works and what the benefits are. We also explore the financial benefits and risks associated with debt recycling and you can watch a short video that explores the concept.
What is debt recycling?
Debt recycling is a strategy used by sophisticated investors to convert non-deductible debt into deductible debt. But what does that actually mean?
Deductible debt is any debt where you can claim the interest as a tax deduction. For example, a loan used to purchase an investment property allows you to claim the interest charged in your tax return.
Non-deductible debt, on the other hand, is debt you can’t claim as a tax deduction. This is typically debt that isn’t secured against an asset that’s growing your wealth. For example, a personal loan used to fund a holiday is considered non-deductible.
How does debt recycling work?
It’s actually pretty straightforward.
If you own a property, you can leverage the equity in that property to invest in rental property or shares through an investment loan. The interest on the investment loan becomes tax deductible, whereas the loan on your owner-occupied home is not.
You then use the tax savings and any investment income to pay down the non-deductible debt as quickly as possible. The idea is to progressively shift debt from your non-deductible home loan to deductible investment loans, increasing your wealth while reducing non-deductible interest costs.
Why would someone use debt recycling?
Debt recycling can be a smart move from a tax perspective, particularly if you have a high income, as it helps reduce your taxable income. It’s also a way to finance future investments without needing to dip into your cash savings.
Benefits of debt recycling
Some of the key benefits of debt recycling include:
- Reducing non-deductible debt
- Paying off your principal place of residence sooner
- Increasing your overall wealth and investments
- Reducing your taxable income
If you simply pay off your home loan at the rate set by the bank, it may take 20–30 years to become debt-free and you’ll pay a significant amount in interest along the way.
By using other investment vehicles, you can improve your overall wealth position, optimise your tax deductions, and pay off your home loan faster thanks to investment income and potential capital growth.
Are there any risks in debt recycling?
Yes, as with any investment strategy, there are risks you need to consider.
First and foremost, you must have the income to service two loans. This can come from employment income, rental income, and/or investment income.
You also have to consider if you are investing in something like shares, the loan is going to be secured against your family home which you need to be comfortable with.
Debt recycling is also a long-term strategy for wealth accumulation, much like property investing. Don’t think of it as a short-term, 12-month plan it’s more of a 7–10 year commitment.
Ready to explore debt recycling?
Debt recycling can be a powerful strategy to help you pay off your home sooner, build long-term wealth, and reduce your tax bill but it’s not for everyone. The right approach depends on your income, goals, risk tolerance, and personal circumstances.
That’s where we come in. Our experienced mortgage brokers can help you understand whether debt recycling is right for you, and guide you through the process step by step.
Book a meeting with one of our brokers today to discuss your options and start putting your money to work.