Turning home equity into profit

This is our third article on debt recycling. You can view our first article “Turning bad debt into good debt” here.

In this edition, we will discuss a topic many people may have some general knowledge of but may not know how it can be leveraged to its maximum potential via debt recycling.

The humble family home

In our last edition, we looked at good debt versus bad debt as part of the overall debt recycling strategy.

We highlighted that while it is common to believe the family home is the answer to our economic prayers, it is in fact, a poor incoming producing asset.

Why?

While there is no question the family home in Australia has grown in dramatic capital value over past decades, it does not 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.

So, as a stand-alone income producing investment, it is the equivalent of a credit card!

Yes, capital growth may be accruing in the background, however, there are on-going after tax interest payments going out and no income coming in.

So how do you turn your home into a tax-effective, income-earning investment vehicle?

Let us first remind ourselves what debt recycling is.

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, debt recycling is the process of replacing non-deductible debt with deductible debt.

Leveraging the humble home

The first part of a debt recycling strategy is actually very similar to purchasing an investment property.

You use the lazy (non-performing) equity in your home loan to invest in an income-generating asset. As an added bonus, the equity you are using from your home to purchase the investment becomes tax-effective – which, in simple terms, means you minimise the tax you have to pay.

It should be noted that depending on the performance of the investment, it will be either negatively geared, (where the interest is more than your income), or positively geared, (where the interest is less than your income).

Either way, the interest becomes tax deductible – a win/win.

Let’s step through the process

For those that have paid down some of their home loan and gained equity, we look to progressively redraw this equity to help minimise tax and build long-term wealth.

With this strategy you can:

1. Use the equity in your home to establish an investment loan
2. Invest that borrowed money to buy assets such as property or shares
3. Use the investment income from the investment (as well as any surplus cashflow) to reduce your outstanding home loan balance.

At the end of each year, you then borrow what has have paid off your home loan and then use this money to purchase additional investments.

Ideally, this process progresses each year until your home loan is repaid.  From that point, any surplus income can be used to secure additional investments, or pay down your investment loan or go on an extravagant holiday!

The underlying benefits of this are pretty straightforward.

1. Progressively convert your non-tax-deductible home loan into a tax-deductible investment loan – so bad debt into good debt.
2. Build up an investment portfolio over time to help meet your long-term financial goals.

In a nutshell

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

Leverage your home equity progressively (you do not have to own your home outright)

Ensure you will not have to sacrifice your current lifestyle

Build investments (and wealth)

Save on tax