Debt Recycling

What is Debt Recycling?

Debt recycling is a strategy homeowners use to convert home loan debt into tax deductible investment debt. Think of it as converting bad debt (i.e. home loan debt, which you’d likely want to pay down ASAP) to good debt (i.e. investment debt, which carries tax deductible interest repayments and can reduce your tax obligations).

By gradually replacing your mortgage with investment debt, you might be able to pay down your home loan while simultaneously investing in assets like shares, residential property or commercial real estate, potentially building wealth and improving your financial situation over time.

Given an investment loan typically offers tax deductible interest, debt recycling is a very handy, tax-effective tool for owner occupiers.

Is debt recycling a good idea?

Like with any financial strategy, it depends on your personal situation.

Debt recycling can be a powerful tool for Aussies looking to accelerate their financial growth, converting their post-tax debt (i.e. debt paid down using after-tax dollars) to debt that carries tax deductible interest repayments.

But it isn’t for everyone. Here are some factors owner occupiers should think about before diving into debt recycling:

Potential benefits

• Tax deductions: Interest on investment loans is tax deductible, allowing you to reduce your taxable income and your tax obligations.
• Wealth creation: By investing in assets that grow over time (alongside owning your home), you have the opportunity to build wealth.
• Mortgage reduction: You can prioritise paying down your mortgage while also dipping your toe in income producing investments.

Risks to consider

• Market exposure: Every investment carries risk. And your investments could lose value, especially those in volatile asset classes, such as shares.
• Complexity: Debt recycling is more complex than standard mortgage repayments and often require expert advice.

If you’re willing to tolerate some risk and go down a more complex path to wealth, then debt recycling could very well be a strategy to consider discussing with your accountant or financial planner.

How do you set up debt recycling?

If debt recycling is a new concept to you, take the time to understand it before diving in. Like with any investment or new financial strategy, success typically comes from the actions you take before you buy or invest (i.e. doing your due diligence).

Here’s how you might get started:

1. Understand your financial situation: Easier said than done, you should take stock of both sides of your ledger: your assets, your debt and your income. Assess your mortgage, savings, risk tolerance and long-term financial goals.
2. Use a split loan structure: To debt recycle, investor-owner occupiers will convert part of their home loan into an investment loan while maintaining a separate mortgage for their personal residence.
3. Invest in growth and cash flow assets: A debt recycler will use funds from the investment loan to buy assets like shares or property—or even invest alongside professionals in property syndicates—that offer long-term growth potential.
4. Reinvest the returns: As your investments generate income, either from rental income or dividends, you might reinvest it into paying down your mortgage. You’ll thus reduce your “bad debt” with the proceeds of your investment.
5. Consult a financial advisor: But before starting the process, and because debt recycling is a sophisticated strategy, you’ll want to work with a financial advisor to ensure you navigate the complexities properly and maximise the benefits.

Is debt recycling right for you?

Debt recycling could be a game changer if you’re committed to long-term financial growth and comfortable with a degree of market risk (the risk level is dependant on the specific investment, the market and a range of other factors). It offers handy tax advantages while still focusing on reducing your home loan—but the strategy isn’t without challenges.

It’s important to carefully evaluate your financial position, risk tolerance and investment knowledge before embarking on this journey. And as we always remind readers and investors, the best way to do so is with your accountant or trusted financial planner.