Debt recycling, what is it and does it suit you?

Debt recycling is a financial strategy that involves converting non-deductible debt, such as a home loan, into deductible debt, such as an investment loan. By doing this, you can reduce your tax liability and increase your wealth over time. Debt recycling works by using the equity in your home to borrow money for investing in income-producing assets, such as shares or property. The interest on the investment loan is tax-deductible, while the income from the investment can be used to pay off the non-deductible home loan faster. This way, you are recycling your debt from non-deductible to deductible and creating a positive feedback loop that accelerates your wealth creation.

Debt recycling can be a tax-effective strategy to minimise your tax liability each year, as you can claim a tax deduction for the interest on the investment loan. This reduces your taxable income and lowers your tax bill. For example, if you have a taxable income of $150,000 and pay $10,000 of interest on an investment loan, you can reduce your taxable income to $140,000 and save $3,900 in tax (assuming a marginal tax rate of 39%, including Medicare levy). On the other hand, if you pay $10,000 of interest on a non-deductible home loan, you cannot claim any tax deduction.

Debt recycling can also help you build wealth faster by leveraging the power of compounding returns. By investing in assets that generate income and capital growth, you can increase your net worth over time. For example, if you invest $100,000 in shares that pay a 5% dividend and grow by 7% per year, after ten years, you could have up to $259,374 worth of shares. If you use the dividends to pay off your home loan faster, you will save more interest and free up more cash flow for investing.

Debt recycling is not without risks, however. It involves taking on more debt and exposing yourself to market fluctuations. If the value of your investments falls or the income from them drops, you may end up with negative equity or cash flow problems. You must also consider the costs and fees of setting up and maintaining the loans and investments. Therefore, debt recycling is not suitable for everyone and requires careful planning and professional advice.