There’s been a lot of talk in the media lately about debt recycling, and you might be wondering if it’s something worth considering for yourself.
Debt recycling is a strategy that helps you pay off your mortgage faster while investing at the same time. Sounds too good to be true?
Let’s break it down in simple terms.
You’ve got a mortgage – we all know that’s something you just chip away at over time. But with debt recycling, instead of only focusing on paying off your home loan, you borrow against the equity you’ve built up in your home to invest in things like shares or property.
Now, here’s where it gets interesting: while the interest on your home loan isn’t tax-deductible, the interest on money borrowed for investments is. So, not only are you investing to potentially grow your wealth, but you’re also getting a nice tax break at the same time.
And if your investments pay dividends, that’s extra cash flow you can use to help pay down your mortgage even faster. It’s a win-win – you reduce your debt and build wealth at the same time.
Of course, the goal is that your investments grow over time, and as they do, you can use the returns to pay off even more of your mortgage. But keep in mind, like any strategy, it’s not without its risks – your investments need to perform well for it to really pay off.
Now, let’s explore a few additional perspectives on how debt recycling could work for you:
Debt Recycling to accelerate your wealth creation
Your in a good place – mortgage is still there but under control with plenty of equity available and you still have surplus income to spare at the end of each month and you’re scratching your head at what to do. You think:
- Investment property? Adecent investment property is edging towards $1m and you dont really want the financial pressure of the mortgage required to achieve this.
- Shares? I’ll buy a couple of thousand worth here and there but I don’t know enough to manage a meaningful portfolio.
- Make extra repayments on the mortgage/throw it in the offset account? Surely there’s a strategy to get your money working harder.
By debt recycling, you can invest and pay down your home loan faster. So whilst your levels of debt might increase initially, they will reduce over time and be converted from “bad debt” to “good debt”. Once your home loan is paid off, your circumstances will determine whether it best to start repaying it over time or maintain it to offset the investment income.
One of my personal beliefs is that too much debt is the only thing that can “blow up” your financial situation. One of the major benefits of debt recycling into a quality diversified portfolio is that you have flexibility and control the level of debt/investment exposure, making it an easier task to manage the risk and adjust to your inevitable life changes and not have your lifestyle being dictated by your wealth creation strategies.
Debt Recycling in a High-Interest Rate World
Many people see debt recycling as less attractive when interest rates are high due to increased borrowing costs. However, there’s another perspective to consider.
The key is to ensure your investment returns exceed the after-tax interest rate over the investment period. For example, if your interest rate is 6.5% per annum and you’re on the highest marginal tax rate of 47% (including the Medicare levy), your after-tax interest rate effectively drops to 3.44% per annum. When compared to the historical average return of 7.5%* per annum on a growth portfolio, the net benefit would be approximately 4.06% per annum.
While you could achieve similar returns with a high-interest savings account, investment returns tend to be more tax-efficient over the long term, especially when factoring in franking credits and capital gains tax discounts. Additionally, it’s worth noting that we are likely near the peak of the current interest rate cycle. As rates decrease, both savings account interest and loan interest are expected to fall, potentially widening the benefits of debt recycling over time. For instance, if interest rates drop to 5% per annum, the after-tax interest rate in this scenario would fall to 2.65%, increasing the net benefit to around 4.85% per annum.
This example looks at gearing on its own, without factoring in any additional savings from mortgage repayments.
If you’re looking to optimise your financial strategy, debt recycling could be an ideal pathway, even when interest rates are at a peak. Book a call, if you’d like to discuss how this strategy might work within your broader financial plan.
