Turning bad debt into good debt

This is our second article on debt recycling. You can view our first article “What is debt recycling?” here.

In this edition, we will create some magic by explaining how bad debt can be turned into good debt and how this works as part of the debt recycling process.

OK, let’s start at the beginning.

Is your home an asset?

We are all led to believe that your home, your castle – the pinnacle of Australian life – is an asset and indeed, one that keeps on giving financially. Is it?

Not necessarily.

While history has shown the humble family home has grown in (capital) value over past decades, it doesn’t produce any direct income while you live in it.

In addition, the interest payments you make as part of your home mortgage are not tax deductible (like an investment loan) meaning you are paying your loan off with after tax dollars.

What does this mean?

It means the family home, as an investment vehicle , is largely inefficient and expensive – so essentially a bad debt.

OK, so how does debt recycling make a bad debt a good debt?

Let’s start with an overview of debt recycling for those for those that didn’t get to read our first debt recycling blog.

Debt recycling is a financial strategy that can help pay off non-deductible debt – typically a home loan – as quickly as possible. While doing this, help build additional wealth and minimise tax.

So in short, a process of replacing non-deductible debt with deductible debt to minimise your tax liability and create wealth.

Good versus bad

Debt recycling strategies essentially help reduce ‘bad’ debt and use ‘good’ debt to create wealth and minimise tax. Good debt is typically tax-deductible and used to buy income producing assets such as an investment property or shares.

Bad debt on the other hand is debt used to purchase something (indeed, anything) that doesn’t generate income or that loses its value or has no value once it’s been used. Think credit cards, personal loans and yes, even home loans!

In addition, there is typically no tax deductions allowed and the borrower has to pay the loan interest via their own after-tax cash resources.

So, how do we change bad into good?

The first goal is to minimise or eliminate your home loan debt as it is non-deductible or bad debt and turn it into tax deductible or good debt.

With debt recycling, you can leverage the equity in your home loan to invest in income earning investments. The interest on the debt used to invest now becomes tax deductible – or good debt!

So rather than waiting for years to earn enough equity in your home to purchase an investment property, debt recycling allows you to utilise small, progressive amounts of your home’s equity to invest in select investments.

These small amounts then create a reduction in your home loan and help you take advantage of compounding.

While we will discuss the benefits of compounding in a future article, it is important to note that compounding is all about time and the sooner you invest, the sooner the compounding benefits of your investment will speed up paying down your home loan

This process is repeated until your home loan is paid off and you are building external wealth and minimising tax.

So, bad debt becomes good debt!

In a nutshell

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

Turn your bad debt into good debt

Ensure you won’t have to sacrifice your current lifestyle

Build investments (and wealth)

Save on tax