Transform Your Mortgage with Debt Recycling

In the current economic climate with rising costs, optimising resource allocation is crucial. While expenditure reduction has likely reached a practical limit for many, alternative strategies are necessary to achieve financial progress. This necessitates exploring methods to maximize the returns on existing investments and identify pathways towards growth that transcend mere cost-cutting measures.

The Australian Bureau of Statistics (ABS) shows the average mortgage in Australia was a whopping $584,907 at the end of 2023, with interest rates hovering around 7.26%. That's a lot of money going out the door with no tax benefit.

Debt Recycling for Homeowners

Debt recycling is a strategy that transforms your existing bad debt, such as your mortgage, into good debt that is tax-deductible. Essentially, it involves using the equity in your non-tax-deductible asset (your mortgage) to invest in income-producing assets, which are tax-deductible. The income generated from these investments is then used to pay off your home loan. Once your home loan is fully repaid, only the tax-deductible loan on your investment assets remains.

This concept might seem complex at first, but don't worry! We'll explain everything in detail for you.

How this works

The best way to explain how debt recycling potentially minimises your tax liability is to use an example. 

Let’s say your house is worth $550,000, but you still owe $300,000 on your mortgage. That means you've built up $250,000 in equity.

To recycle debt, you would use the existing equity in your home to establish an investment loan. When you refinance your home for $440,000, this will release $140,000 of equity. You would then invest the $140,000 in income-producing assets, such as shares, property, managed funds etc. The interest on the investment loan ($140,000) to purchase the income-producing asset is tax-deductible. This means, you can claim a tax deduction for the interest you pay on the new tax-deductible investment loan, which essentially reduces your taxable income and minimises your tax liability.

Earlier, interest on your mortgage i.e. home loan would not have been tax deductible, because it is not an income producing asset.

Now it’s important to realise that you are not actually ‘increasing’ your debt. As you continue to pay off your home loan, you can draw that money out to invest. Over time, as the income from the assets purchased with the separate investment loan grows, you can use that income to pay interest on the original home loan. As the value of the new property increases so does the equity in your new property. 

You can then repeat the process of refinancing your loan to invest in more income-producing assets, further increasing your tax-deductible debt and reducing your non-deductible debt.

As this strategy continues, you’ll see the non-deductible home loan shrink over time, while your ‘tax-deductible investment loan’ grows. The idea is to keep recycling your debt until you have effectively moved all your debt into a tax-deductible position.

Conclusion

Debt recycling offers homeowners a smart way to transform non-deductible debt, such as a mortgage, into tax-deductible debt by investing in income-producing assets. This strategy not only minimizes tax liabilities but also helps grow wealth over time. If you're looking to explore how this could work for you, our team at PlanWise Paraplanning Services specializes in paraplanner financial planning and can provide expert guidance tailored to your financial situation. Let us help you optimize your finances and achieve long-term financial security.

To find out more about our services or to get in touch, feel free to reach out at info@planwiseservices.com.