If you're a homeowner in Australia, you’ve probably been told that paying off your mortgage as quickly as possible is a smart financial move. But what if there was a way to reduce your mortgage while also building long-term wealth? Enter debt recycling—a financial strategy that helps you grow your investments while still chipping away at your home loan.

In this blog, we’ll walk you through what debt recycling is, how it works, and whether it could be the right fit for your financial goals.

What Is Debt Recycling?

Debt recycling is a strategy that allows you to turn your non-deductible debt, like your home loan, into deductible investment debt. In simple terms, it’s a way to use your home’s equity (the amount you’ve paid off) to borrow funds for investment purposes, such as shares or property.

The key advantage of this is that the interest on your investment loan is tax-deductible. Unlike a typical home loan where the interest is paid with after-tax dollars, a debt recycling strategy allows you to claim a tax deduction on the interest from the investment loan. The potential tax savings can then be used to further reduce your mortgage or invest more, creating a cycle of both debt repayment and wealth building.

How Does Debt Recycling Work?

Debt recycling might sound complex, but the process is straightforward once you break it down. Here’s a step-by-step look at how it typically works:

1. Pay down your mortgage: Start by making extra repayments on your home loan. This reduces your non-deductible debt and builds equity in your home. The more equity you have, the more you can borrow later to invest.
2. Borrow against your equity: Once you’ve built up some equity, you can borrow against it to take out an investment loan. The amount you borrow is now considered deductible debt because you’ll be using it to invest in income-generating assets like shares, property, or managed funds.
3. Invest the borrowed funds: Use the borrowed money to invest in assets that will generate income or capital growth over time. The goal is to let your investments grow, providing you with returns that can help reduce your mortgage faster or be reinvested.
4. Claim tax deductions: Since the borrowed money is used for investment, the interest on the investment loan becomes tax-deductible. This can reduce your taxable income, giving you tax savings that you can use to pay down your mortgage faster or invest further.
5. Repeat the process: As you continue to pay down your home loan, you can keep borrowing against your growing equity to invest more, thereby repeating the cycle of reducing non-deductible debt while building a portfolio of assets.

An Example of Debt Recycling in Action

Imagine you have a $600,000 mortgage and have paid off $50,000 of it. With debt recycling, you could take out a $50,000 investment loan using that equity and invest it in shares. The interest on the $50,000 investment loan becomes tax-deductible, and any income (e.g., dividends) generated from the shares can be used to pay off your home loan faster.

Not only does this reduce your mortgage, but it also helps you build wealth through your investments. Over time, you repeat this cycle, turning your home’s equity into an investment engine that could provide long-term financial benefits.

Benefits of Debt Recycling

Debt recycling offers two major benefits: tax efficiency and wealth creation.

1. Tax Deductibility: One of the biggest advantages of debt recycling is the ability to claim a tax deduction on the interest from your investment loan. Normally, the interest on your home loan isn’t tax-deductible, so you’re paying it with after-tax dollars. But by turning part of your home loan into an investment loan, you can reduce your taxable income, potentially resulting in significant tax savings.
2. Wealth Building: Instead of focusing solely on paying off your mortgage, debt recycling allows you to grow your wealth while reducing debt. By investing in income-generating assets like shares or property, you can build a portfolio that grows over time, providing capital growth and passive income that can help pay off your mortgage faster and give you greater financial security in retirement.

Risks of Debt Recycling

While debt recycling can be a powerful tool, it’s important to be aware of the risks involved.

1. Investment Risk: Like any investment, there’s no guarantee your assets will perform well. If the market declines, the value of your investment could drop, leaving you with both a mortgage and an investment loan to manage. It’s crucial to have a long-term outlook and be prepared for fluctuations in the market.
2. Interest Rate Risk: Debt recycling depends on taking out additional loans, which means you’re exposed to interest rate movements. If interest rates rise, both your home loan and your investment loan could become more expensive to manage.
3. Long-Term Commitment: Debt recycling isn’t a get-rich-quick strategy. It requires discipline and time to see the benefits. If you’re looking for short-term gains or aren’t comfortable with market volatility, this may not be the right strategy for you.

Is Debt Recycling Right for You?

Debt recycling is a great strategy for some, but it’s not for everyone. Here are some factors to consider before diving in:

1. Risk Tolerance: Are you comfortable with the possibility of market fluctuations? Debt recycling involves investing borrowed money, which carries a certain level of risk. If you’re not comfortable with investment risk, this strategy may not suit your financial goals.
2. Stable Income: Since debt recycling involves managing both a home loan and an investment loan, you’ll need a stable income to comfortably handle repayments, even in tough market conditions or if interest rates rise.
3. Long-Term Financial Goals: Debt recycling works best if you have a long-term view on wealth creation. If you plan on selling your home soon or don’t have a clear long-term investment strategy, this might not be the right option.

Steps to Get Started with Debt Recycling

If you’ve assessed your situation and think debt recycling could work for you, here’s how to get started:

1. Consult with a Financial Adviser: Debt recycling is a complex strategy, and professional advice is essential. A financial adviser can help you assess whether this approach aligns with your goals and risk tolerance.
2. Review Your Mortgage: Look at your mortgage balance and the equity you’ve built up. This will give you a clearer idea of how much you can borrow to invest.
3. Create a Clear Plan: Work with your adviser to develop a solid strategy that outlines how much extra you’ll repay into your mortgage, how much you’ll borrow for investments, and what assets you’ll invest in.
4. Start Investing: Once you have a plan in place, start making extra mortgage repayments and borrowing against your home equity to invest. Regularly monitor your investments and make adjustments as necessary.

Conclusion

Debt recycling can be a powerful strategy for building wealth while paying off your home loan. By converting non-deductible debt into tax-deductible investment debt, you can create a cycle of wealth creation that works alongside your goal of becoming mortgage-free.

However, it’s important to carefully consider the risks involved and ensure that this strategy aligns with your financial goals. Consulting with a financial adviser can help you determine if debt recycling is the right path for you. If you’re looking for a way to boost your financial future while managing your mortgage, debt recycling might be the solution you’ve been searching for.

Ally Home Loans Pty Ltd is your ally in finance for all of your home loan, investment property, business and commercial financing needs. With our wide range of lending solutions, expertise in financial planning and investment strategies, and extensive experience in working with both Australian residents and Australian expats, we are your partners for your lending needs.

Book an obligation-free, complimentary consultation here today.

Ally Home Loans Pty Ltd is an Authorised Credit Representative (Credit Representative Number – 494608) of My Local Broker (Australian Credit License – 481374). Important Disclaimer: Your complete financial situation will need to be assessed before acceptance of any proposal or product.