Debt Recycling Explained: Understanding the Concept and Mechanics

Debt recycling can be a useful strategy to build wealth while paying off a home loan, so could this strategy be suitable for you?

What Is Debt Recycling? Debt recycling refers to using one debt to pay down another for financial gain, often by switching out non-tax deductible debt such as your home mortgage for tax-deductible loan interest – potentially helping pay off your home sooner, reduce tax payments, and build wealth.

Recycling debt also involves using short-term credit, such as a credit card, to minimize interest payments on your home loan by saving as much in an offset account as possible.

How Does Debt Recycling Work? If your debt recycling strategy involves purchasing an investment property, then take some of your equity out by taking out a new loan and using that money for another investment asset.

As opposed to your home loan, any investments loans should be tax-deductible, meaning any interest payments on these investments loans can be offset against your income in order to lower the taxes you owe.

At the same time, any investments you purchase with borrowed money should yield returns that help reduce your home loan more quickly.

Over time, your investments should increase in value – just like your home has done – enabling you to use that additional capital gain towards paying off your home loan. Your ultimate goal should be paying it off with both income and increased equity in investments so that debt shifts entirely away from housing loans and towards investments.

As your investments increase in value, any additional equity you create can also be applied towards paying down home loan or other debt.

Debt Recycling Method 1: Utilizing Investment Properties as Mortgage Payoff Options Many people use debt recycling as a strategy for paying off the mortgage on their primary residence through debt recycling. Here’s one way this can work.

Emma (43), Peter (45) and their home is valued at $1,200,000 with a home loan balance of $500,000. To build equity they decide to take out a $300,000 loan against some of their equity to buy an investment property worth $1,000,000.

Emma and Peter then use the income generated from their investment property to pay directly into their home loan, deducting repayments from pre-tax income to lower their overall tax bill.

As equity increases in their home and investment property, homeowners typically increase the size of their investment loan while paying down their home loan until it has been completely paid off and replaced by their investment loan.

Although they now have a substantial investment loan, with no mortgage to worry about they can dedicate all their income toward repaying its principal.

Otherwise, they could use it to buy more investment properties or assets to broaden their investment portfolios.

Debt Recycling Method 2: Utilizing Credit Cards as Offset Accounts mes Another simple form of debt recycling involves using interest free days on your credit card to keep your offset account as full as possible.

To utilize this strategy, place all income – salary, bonuses, lump sums or any other payments – into an offset account and all living expenses onto credit card.

By paying off your credit card each month just before it falls due, you’ll ensure as much money remains in your offset account for as long as possible, thus decreasing interest payments while contributing more directly towards principal repayment.

Say, for instance, you have an outstanding mortgage balance of $400,000 and have $40,000 saved up in an offset account.

Your mortgage repayments would remain the same; however, over time the principal would be reduced significantly faster as only interest will be owed on this sum.