What is debt recycling?
Debt recycling is a method used to pay off non-deductible debt such as your mortgage by using the equity you have built up in your home to invest in income producing assets such as shares and property. The way it works is that you take the income from your investments and direct it towards your home loan, increasing your repayments, meaning you will be paying your home loan down faster.
Whilst you are making extra payments on your home loan you are increasing the amount of equity in your home, giving you the ability to borrow more money and invest it again.
This means that you are shifting the non tax-deductible debt from your home loan to the investment loan which the interest payable is 100% tax deductible.
Utilising a strategy like debt recycling can help you build your wealth and repay your home loan faster, it does also amplifies the risks you may encounter in the face of a market turndown.
Making sure that a debt recycling strategy is right for you will depend on a number of different factors such as your risk tolerance, investment time frame as well as your short, medium and long term financial goals as you will be reducing your lending capabilities due to a decreased serviceability.
How it works
The best way to explain how debt recycling works is to use an example.
Let’s say your home is worth $1,000,000 and your remaining mortgage is $600,000.
You technically have $400,000 of equity you can borrow, but most lenders will only lend you 80% of the value of your home (a ratio known as the LVR), minus your mortgage otherwise lenders will charge you lenders mortgage insurance which will be counter productive.
Eighty per cent of $1,000,000 is $800,000. Take the $600,00 of your mortgage away from that, and you are left with usable equity of $200,000.
Next, you take out $200,000 of that equity as a tax-deductible investment loan and put it into income-earning assets such as shares, ETFs and mutual funds.
Over the next year, your investments increase in value by $16,000 and yield an income of $12,000.
You take that $12,000 of investment income and put it towards paying off your mortgage. Added to regular principal repayments on your mortgage totalling $14,000, you reduce your mortgage by $26,000 in the year.
This has now increased the equity in your home by $26,000 which gives you the ability to borrow again and invest it into more income-earning assets.
The process is then repeated until your mortgage is paid off.
Who can do it?
A debt recycling strategy is not for everyone as it is not accessible for everyone. There is some specific criteria which you need to mee to be eligible for this strategy.
The main benefits of a debt recycling strategy are:
The main risk of a debt recycling strategy are:
Still unsure about debt recycling and whether it is right for you?
We Can Help!
We have helped those just like you make the most of debt recycling to achieve their financial goals. First, we begin by assessing your particular financial situation and short, medium and long-term financial goals before helping you to decide whether debt recycling is the right strategy for you.
But before we can do any of that, we need to get to know you a little better.
Don’t wait, let us help you continue to make smart investment decisions.
This publication consists of general and factual information only. Its contents cannot be substituted for professional financial advice. Why? Because the information does not take into account your individual objectives, financial situation or needs. It is strongly recommended that you do not act on any information contained before seeking personalised advice from a licensed financial adviser. We are suitably qualified to discuss everything covered in this publication and encourage you to contact us if you have further questions about this material. Always remember, before you invest in any financial product you should obtain, read and understand the related Product Disclosure Statement and determine if it is suitable for your personal situation.
Terrell Hyman the Director and Principal Advisor at Trl Financial Solutions.