What is debt recycling? A simple strategy that produces a significant outcome
DEBT RECYCLING IS A SIMPLe STRATEGY THAT IS underutilized BY WEALTH CREATORS. IN THIS POST, I WANT TO EXPLAIN HOW IT WORKS so you can consider if it's something you might want to use for yourself.
HOW DOES DEBT RECYCLING WORK?
The financial services industry is not known for its creative endeavours, so this strategy is as the name suggests i.e. transforming bad debt (non-deductible) into good debt (deductible). I must stress this is not a way to pay off your home loan sooner. Unfortunately, if you research this topic, there are many misleading headlines out there such as, “How to pay off your home loan inside 10 years” etc.
In any event, the basic premise is once enough equity has been built up in your family home, a seperate loan facility is set up and used to purchase an income generating investment asset such as a diversified share portfolio or an investment property.
Income generated from the investment asset such as rent or dividends is used to assist paying down your home loan whilst at the same time, the loan that was used to purchase the investment will increase.
Over time, the extra loan repayments in your home loan are transferred into your investment loan and then reinvested.
Eventually the debt associated with the family home loan will be paid off, replaced or ‘recycled’ with a loan that you can now claim an interest deduction against.
WHAT'S THE BENEFIT TO A DEBT RECYCLING STRATEGY?
The obvious benefit with this strategy is the more interest you can claim a deduction on, the larger your tax return will be. This money can then be used to pay down further debt or acquire other investment assets.
WHAT'S THE BEST LOAN STRUCTURE?
For this strategy to work without too many headaches, it’s important for the investment loan to be able to pay interest and other costs associated with the investment from the loan itself.
The best loan for this is a line of credit facility that has the functionality to capitalise over time. Please note that not every lender has this type of loan available so make sure you ask for that functionality when completing your lender research.
SEEK FINANCIAL ADVICE
Before deciding to proceed with a debt recycling strategy, it’s important to obtain independent financial advice from either an accountant or financial planner. It is critical that they are happy with the strategy and can also provide some modelling and projections to make sure that the investment loan does not increase at a higher rate then the home loan decreases.