What is debt recycling?

While it may sound a little counter intuitive, debt recycling is a little known, yet highly lucrative financial strategy that brings together three of the most important financial planning disciplines to help build remarkable, long-term wealth.

1. Paying your home loan off sooner
2. Building an investment portfolio
3. Minimising tax.

Surprisingly, given its clear benefits and wealth creation advantages, financial institutions may talk about debt recycling, yet only a few engage it for clients and even fewer do so successfully.

We should note upfront that for debt recycling to be effective, it is important you secure the services and support of a professional financial adviser that understands the process and indeed, each client’s unique position.

This blog is the first in a series of six we will send out (one each week), to explain the debt recycling process and hopefully, encourage you to consider it as a genuine wealth strategy.

Let’s begin with what debt recycling actually is, some things you need to consider, and some key benefits.

A simple explanation

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

The process involves replacing or ‘recycling’ the debt in your family home with tax-deductible debt from investments. Over time, the earnings from these investments – paid toward your home loan, will help to pay it off much faster than if you were just making regular payments.

We all know paying down your home loan faster can save you tens of thousands of dollars in interest and with the added benefits of creating additional wealth and reducing your tax liabilities, it can be a remarkable financial strategy.

What do I need to be able to take advantage of debt recycling?

OK, for debt recycling to work, there are a few things you need and a few things you need to consider.

• You need a long-term investment mindset
• You need an existing home loan and have some equity (ownership) in your home
• You need to have a regular income (earned independently of the debt recycling process).
• Even though considered good debt, you need a willingness or tolerance to have increased debt and hold an investment loan
• You need to be OK with some risk and short-term fluctuations in investment value. This is typical of most investments
• You will need to consider reviewing your personal insurances including life, TPD, income protection and trauma insurance which will give you both income security and peace of mind.

What are some of the immediate benefits?

Paying down your home loan

The big advantage is that you are able to invest immediately rather than waiting for your home loan to be paid off.

Second, it allows you to compound your earnings – we will look at details of ‘compounding’ in another of our debt recycling series – but that said, compounding earnings means you can pay off your home loan a great deal faster!

Third, by directing investment and other available income into your home loan, you can dramatically reduce the cost of your loan.

Wealth building

Borrowing to invest is an essential part of the process and can be particularly effective as you can deduct the interest you pay – also known as negative gearing. Because of this tax deductibility, you create tax savings which you can put toward your home loan. This is particularly beneficial for those on higher tax rates. In addition, if your new investments increase in value, you are building wealth at the same time.

At the end of the first year, the goal is to have increased your investment loan by the same amount you have paid off your home loan and to have reinvested that increased amount. Ideally you repeat this process each year until your investment loan entirely replaces your home loan!

In a nutshell

Debt recycling, when done via a professional financial planner will:

Own your home sooner

Ensure you won’t have to sacrifice your current lifestyle

Build investments (and wealth)

Save on tax