Debt recycling: Compounding for wealth creation

Compounding for wealth creation

The benefits of compounding interest as part of the debt recycling strategy

This is our fifth article on debt recycling. You can view our fourth article “Using investment income to fast track home loan repayments and reduce tax” here.

In this edition we look at the benefits of compounding interest as part of the debt recycling strategy and through our process, how you can maximise this to pay down your bad debt (and interest) much faster than simply by making regular repayments.

Albert Einstein is reputed to have said:

“Compound interest is the eighth wonder of the world. He who understands it, earns it. He who doesn’t, pays it.”

He was absolutely spot on! Let’s see why.

Investment income

In our last edition, we looked at the benefits of using income derived directly from your investment(s) to dramatically speed up the home loan repayment process. We also identified the tax benefits that resulted from using this investment income strategy.

Let’s now see how the process of compounding – as part of the debt recycling process – can not only increase your investment portfolio, but dramatically reduce your home loan term and total interest repayments.

The compounding conundrum

As ‘compound interest’ can be confusing  for many, we have provided a simple explanation before we look at how it works in debt recycling.

Compound interest – when discussing savings – is when you earn interest on your savings and then the following year, you earn interest on your interest!

Here is a simple  example:

  1. You save $100 at a 2% interest rate
  2. Your annual interest is $2 so you now have $102.
  3. Next year you earn $2.04 in interest because the 2% is based on the $102
  4. The follow year you have $104.04 earning 2%

And this goes on over time, getting bigger and bigger! It is, quite simply, the result of reinvesting the interest owed, rather than paying it out.

A reversal of compounding

The old adage of paying down your home loan first is actually very important. Indeed, the more equity you have, the less interest you have to pay on an ongoing basis.

But of course, most of you know this!

What you may not know is that reversing the compounding or using income from your investment to pay down your loan will mean there is LESS interest on interest to pay on your home loan.

So, this means you are paying less interest on your home loan and securing greater equity. The bottom line? You own your home much faster.

In practical terms

So compounding works in two ways – negative and positive.

  1. Investment compounding is good!
  2. Home loan / debt compounding is bad so the faster you knock down the home loan the better as it reverses the compounding effect of interest on interest.

In a debt recycling strategy, you actually use the positive compounding effect of the income from the investment to help pay down your home loan faster increasing your equity and reducing the interest payable (also known as negative compounding).

In a nutshell

So, when done via a professional debt recycler, you can:

Interested in Debt Recycling?

Always seek the advice of a financial professional

At Debt Recyclers, we have a sound understanding of this financial strategy and can advise and guide clients on the best way to identify the best compounding process to reduce your home loan interest and principal.

We encourage you to have an obligation free discussion with us to determine your suitability.

Book a free consultation