What is Debt Recycling?
Debt recycling is about making your debt work for you. It involves paying off your non-deductible debt (home loan) and replacing it (recycling) with deductible debt to create wealth. Why is deductible good? It means you can claim a tax deduction for any interest paid on the loan which in turn will reduce the tax you pay. You make the same repayments but also get a reduction in your tax. You can then use these funds to create wealth through an investment property or portfolio.
How does it work?
Importantly, it's not for everyone.
- You need a home loan with some equity to draw down.
- It suits a long-term investment horizon.
- You must have a high tolerance for risk and willingness to ride short term fluctuations in investment markets.
- Strong cashflow is a must! A great buffer of cash flow surplus will make the volatility easier to bare and strategy easier to maintain.
- Income protection insurance should be considered to protect your income if you are unable to work due to illness or injury. Refer to the Personal Insurance Knowledge Hub for more information.
What are the benefits?
- Debt recycling allows you to build more tax-effective debt (and reduce the non-deductible debt) for the purpose of building an investment portfolio.
- You may pay off your home loan sooner.
- Using debt to increase your investment portfolio gives you access to potentially more capital growth and income.
- Having a larger investment portfolio with the use of debt allows you to increase the diversity of investments which in turn reduces your risk by spreading the risk across different asset classes.
What should I be thinking about?
- Just as having an increased portfolio size can magnify your gains, they can also magnify your losses when the markets go down. Volatility in your portfolio will be higher. It is important that you are comfortable with this. A minimum of 7 years is recommended for this type of strategy.
- Interest rates are subject to change. This will impact your cash flow.
- Debt recycling requires regular review to draw down on debt and invest these funds for your wealth creation strategy.