Debt recycling enables you to simultaneously pay off non-deductible debts (such as your home loan) and build an investment portfolio for your long term future goals.
Benefits of debt recycling
- You can use the equity in your home to take advantage of market opportunities now, rather than waiting for your mortgage to be repaid.
- You will be diversifying your investments outside of the family home.
- Building an investment portfolio now allows it to benefit from the power of compounding and long term investment growth.
- Regular investing means you benefit from dollar cost averaging, because sometimes you pay more, sometimes less, for your investment, so your average purchase price essentially evens out over time.
- Your taxable income may reduce as your deductible loan increases.
- Your home loan may be repaid faster.
- You will be able to access your investment portfolio if necessary.
How debt recycling works
To use debt recycling, you need an existing home loan (or other non-deductible debt) and an investment loan. Your investment loan should be structured as an interest only loan and the funds invested in income-producing assets, such as managed funds or shares.
To implement the strategy, you arrange for all of your investment income to be directed to your home loan in addition to your regular repayments. The extra repayments increase your equity in your home, allowing you to increase your investment loan by the amount you’ve repaid on your home loan. This additional money is then used to increase your investment portfolio.
Over time, as your investment portfolio grows, so does your investment income and the amount you can use to repay your home loan.
Structuring your investment loan as interest only means your repayments are less than if the loan was principal and interest which allows you to direct more of your cash flow to your home loan. The cost of an investment loan is usually tax deductible if the investment is producing taxable income for you, so the interest repayments on this loan can reduce the amount of income tax you pay.
You can revisit this strategy periodically, each time increasing your investment loan by the amount that has been repaid on your home loan with the additional money being used to buy more investments. This process can be continued each year until your home loan is fully repaid. After that time, you can use your surplus income to buy more investments or repay your investment loan.
Other things you should know
- Debt recycling is a high risk strategy – if your portfolio performs poorly, or if interest rates increase, you could face significant financial stress or even put your family home at risk.
- Debt recycling involves gearing (borrowing to invest). You need to understand the risks associated with gearing before undertaking a debt recycling strategy.
- All borrowing requires discipline. It is important not to over-commit as this will increase the likelihood that ongoing interest and loan repayments can be met.
- Before making any changes to your loan, you should confirm with your lending specialist what fees and charges may apply if your loan is restructured or if you make additional repayments.
- You should review your life insurance cover regularly as your debt and asset levels change. It is important to have sufficient cover to help meet loan repayments in the event that your income ceases because of illness, disablement or death.
- Tax advice should be sought prior to implementing or making changes to investment related borrowings.