Given the growth we’re experiencing in the property market, we are coming across more clients looking for ways to maximise the value of their equity and find to build their wealth outside of their family home. So here is one strategy that needs consideration “Debt Recycling”. It’s been a buzzword in savvy financial circles but often seems shrouded in complexity so let’s demystify this tactic and see how it could fit into your financial toolkit.
What Exactly is Debt Recycling?
Imagine transforming your regular home loan, which doesn’t offer tax benefits, into an investment loan that does. That’s the essence of debt recycling. It’s about using your mortgage repayments to fund investments, creating a cycle that leverages tax deductions to enhance your returns.
Courtesy of Peter Thornhill
Why Consider Debt Recycling?
Unlike straightforward leverage that ups your debt ante, debt recycling is a nuanced approach. You’re essentially reallocating existing debt for more fruitful outcomes. It’s a strategy that demands finesse and understanding – two things we at Inspired Money excel in guiding you through.
How It Unfolds in Practice
Here’s the crux of it: instead of directly investing your spare cash, use it to pay down your home loan. Then, re-borrow that amount for investment purposes. This cycle not only makes part of your loan tax-deductible but also accelerates your journey towards a more investment-focused financial portfolio.
A Practical Example
1. You have a home worth $500k with a $300k loan. You also have $100k in your offset account.
2. You can split your home loan into two so that you have a $200k loan and a $100k loan.
3. You pay off the $100k loan with your offset money. Then you pull it back out, sending it straight to the investment account (if buying shares).
4. Interest on the $100k loan is now tax deductible, provided you invest in an income-producing asset.
The numbers behind debt recycling
So here’s how it works using nice round numbers for simplicity using the steps above. You have a $300k home loan with a 4% interest rate and $100k in cash.
Option A: Investing without debt recycling:
Invest $100k. Receive $4k of income. If tax takes 50%, you’re left with $2k income.
Option B: Investing with debt recycling:
Pay down $100k of debt (your non-deductible home loan). Redraw $100k and invest it. Receive $4k of income.
This time you can claim $4k of interest as a tax deduction (interest on $100k). You now pay tax on $0k of investment income, which is… nothing.
With both options, you have $300k of debt. You’ve paid the same amount of interest, and you have invested $100k.
But by debt recycling, you’ve saved $2,000 in tax that year compared to if you didn’t. And if interest rates are higher, the tax savings increase.
Tax Efficiency and Increased Returns
This method is more than a tax dodge; it’s about enhancing your investment returns. By reducing the tax bite on your investment income, you effectively increase your overall returns, a crucial aspect of sophisticated wealth building.
A Word of Caution
Debt recycling isn’t a one-size-fits-all miracle. It demands smart money management and a solid grasp of your financial landscape, hence the recommendation to not go down this path on your own. Remember, it’s an enhancement, not the foundation, of your wealth-building journey.
Your Roadmap with Inspired Money
If you’re leaning towards investing in rapid debt elimination, debt recycling offers a more tax-efficient avenue. It’s about smartly structuring your finances to work harder for you.
Our approach at Inspired Money is to guide you through each step. From understanding the nuances of your home loan to tailoring the debt recycling process to suit your unique financial situation, we’re here to navigate this journey with you.
Legal and Ethical Considerations
Rest assured, debt recycling is completely above board. It’s a legitimate strategy acknowledged by the ATO (read it here), provided it’s implemented correctly and for the right reasons.
So is Debt Recycling Right for You?
It’s a potent strategy for those who are comfortable with a bit of complexity in their financial plans. If you’re looking to accelerate your wealth accumulation while efficiently managing your mortgage, debt recycling might just be the key.
Debt recycling is a journey with many facets. Whether it’s clear as day or still a bit foggy, we’re here to help. At Inspired Money, our goal is to align sophisticated strategies like debt recycling with your personal financial aspirations, ensuring a journey towards financial success that’s as informed as it is inspired.
This article was written by Director & Senior Adviser Shane Mitchell and provides general information that should not be considered personalised financial advice. If you have specific questions or concerns book a session to review your situation or any other financial planning issue by contacting Shane directly on 08 6222 7909 or book a meeting directly via his booking page.