Managing a home loan can feel like a never-ending cycle of repayments. You might wonder if there’s a way to make that debt work harder for you, especially come tax time. Many Australians are searching for strategies that don’t just chip away at their loans but turn them into tools for building wealth. If you’re one of them, you’ve probably come across the term debt recycling.
But what is it really, and how can it help you make the most of your money? In this guide, AxJ Finance Brokers will explain debt recycling, showing you how it can transform your home loan into a more efficient part of your financial plan. We’ll walk through the process, tackle common myths, and help you decide if it’s the right fit for your situation. And if it all sounds a bit complex, don’t worry—by the end, you’ll have a clearer understanding of whether this approach could work for you.
What is Debt Recycling?
Debt recycling is a strategy to turn non-deductible debt, like your home loan, into debt that can potentially reduce your tax bill. How? By converting your home loan debt into an investment-related loan, making the interest tax-deductible. It’s a bit like giving your loan a makeover so it can work smarter, not harder. This strategy has gained popularity in Australia, especially among those looking to make their finances more efficient.
Ready to learn how debt recycling can make a difference in your financial plan? Reach out to our team for a free consultation and see if this strategy is right for you.
What Makes a Debt Deductible?
To understand debt recycling, it’s important to know why some debts are tax-deductible while others aren’t. For debt to be deductible, it needs to be used to generate assessable income. For instance, if you take out a loan to buy a rental property, the rent counts as income, so the interest payments on that loan become deductible.
By contrast, the interest payments on your home loan aren’t deductible because your home doesn’t generate income. Debt recycling changes this by redirecting funds into investments that do produce income, making the interest on those funds deductible.
How Does Debt Recycling Work?
Imagine you have some extra cash—maybe a work bonus or some savings that you’d like to put to good use. Instead of simply paying down your home loan faster, you could use that cash to make extra repayments, creating a redraw facility.
A redraw facility allows you to withdraw those extra repayments and use them specifically for investments—like shares, ETFs, or investment properties. Because this withdrawal is now tied to income-producing assets, the interest on this portion of the loan becomes deductible.
Curious if debt recycling could work with your current home loan? Talk to one of our mortgage specialists today to explore your options.
The Mechanics of Debt Recycling
Let’s break it down into steps for clarity:
Make Extra Repayments:
Use your spare cash to make additional repayments on your home loan. This step is crucial for reducing your non-deductible debt and creating room to access those funds for investment purposes.
Create a Redraw or Loan Split:
Ensure your lender offers a redraw facility or allows for a loan split, which keeps the deductible and non-deductible portions of your loan separate. This makes tracking easier when it’s time to claim interest deductions.
Invest the Funds:
Use the redrawn funds for investments like shares or an investment property. The key is ensuring the investment is likely to generate income, which allows you to claim the interest as a deduction.
Monitor and Adjust:
Keep an eye on your investments and the market. Changes in interest rates or investment performance might mean you need to adjust your approach. Regular reviews can help keep your debt recycling on track with your goals.
Repeat the Process:
Use income generated from investments to pay down more of your non-deductible debt. This allows you to access additional funds through the redraw, reinvesting them to continue the cycle. Over time, you’ll increase the portion of your debt that is deductible, potentially reducing overall interest costs while growing your investment portfolio.
What Isn’t Debt Recycling?
Debt recycling is not the same as borrowing more to invest. It’s about using the debt you already have—your home loan—and turning a portion of it into a deductible investment loan. It doesn’t mean taking on new levels of debt unless you choose to. It’s also not a get-rich-quick strategy; it requires patience and a long-term mindset, like any investment.
General Considerations for Successful Debt Recycling
If you’re wondering, “How do I get this right?” here are a few tips to ensure a smooth process:
Create Clear Loan Splits:
Each time you recycle debt, set up a separate loan split. This helps you track deductible interest easily and avoid confusion during tax time. It simplifies the process of identifying which part of your repayments relates to income-generating investments.
Consider Interest-Only Loans Wisely:
Interest-only loans can lower your monthly repayments on the investment portion, freeing up more cash for additional repayments or investments. However, they often come with higher interest rates, so ensure that the investment returns will offset this cost before opting for this approach.
Keep Redraws and Investments Separate:
To avoid issues with the ATO, maintain a clear separation between the funds you withdraw for investments and other accounts. For example, transferring withdrawn funds directly into an investment account ensures the purpose is clear and traceable.
Prepare for Market Fluctuations:
Investments can fluctuate, and having a financial buffer can help you navigate any downturns without needing to sell investments at a loss. Having 3-6 months’ worth of living expenses in savings can provide peace of mind while you wait for markets to recover.
Debunking Common Myths
If you’ve been reading about debt recycling online, you’ve probably come across some scary-sounding myths. Let’s address a few:
“It’s too risky!”
Yes, all investments carry some risk, but a diversified approach can help manage this. Working with a finance broker can tailor the strategy to your comfort level and investment goals.
“You’ll just end up in more debt.”
Debt recycling doesn’t increase your overall debt unless you choose to. It’s about converting existing debt into something that works better for you—potentially reducing non-deductible debt while building a portfolio.
“It’s only for the wealthy.”
While initial cash flow helps, debt recycling can benefit a range of income levels. It’s about smart money management, not necessarily big money. Everyday Australians can use this to save on taxes and build their investments.
“You’ll lose control over your finances.”
Debt recycling is designed to give you more control, not less. You choose when and how much to pay into your loan, what to invest in, and when to reinvest. With regular reviews, you can keep your strategy aligned with your goals.
Bringing It All Together: Is Debt Recycling Right for You?
Debt recycling can transform your home loan into a tool that doesn’t just take money out of your pocket but helps put some back in. It takes time, patience, and a bit of know-how, but with the right approach, it’s entirely doable.
Remember, it’s important to weigh the risks and see if it matches your comfort level with investing. And you don’t have to figure it all out on your own—our team is here to help you navigate the complexities and build a plan that aligns with your financial goals.
If you’re ready to explore your options, or just want to have a chat, reach out to us. With the right guidance, you’ll be on your way to making the most of your home loan and seeing it in a whole new light.
FAQs for Debt Recycling
Not all home loans are suitable for debt recycling. The key is whether your loan has a redraw facility or allows for splitting into separate portions. As mortgage brokers, we can assess your current loan structure and let you know if it’s suitable for debt recycling. If adjustments are needed, we can help you refinance or find a loan that better fits this strategy. Reach out to us to explore your options.
There’s no fixed amount required to start debt recycling, but having a lump sum—such as a bonus or savings—can make the process smoother. Even starting with a smaller sum, like $5,000 or $10,000, can be effective. The key is maintaining a steady cash flow to support extra repayments and investments. We can help you determine a suitable amount and build a plan that fits your situation, ensuring you have the right foundation before starting.
Yes, you can, but it’s essential to prioritise your debts. Typically, high-interest debts like credit cards or personal loans should be paid off before beginning a debt-recycling strategy. By eliminating these high-interest, non-deductible debts first, you’ll be in a stronger position to benefit from debt recycling. As finance brokers, we can guide you through this process, helping you create a debt repayment plan that aligns with your financial goals.
Investments that produce steady income, such as dividend-paying shares, exchange-traded funds (ETFs), or investment properties, are often ideal for debt recycling. The key is choosing investments that are expected to generate assessable income, which makes the interest deductible. We can help you review your investment options, taking into account your risk tolerance, timeline, and financial objectives, so you make the right choices for your debt recycling strategy.
The benefits of debt recycling typically accrue over time, as the cycle of extra repayments and investments builds. It’s not a quick win—it might take a few years to see substantial results, especially as your investment grows and a larger portion of your loan becomes deductible. How long it takes can depend on things like how well the market does, what investments you choose, and how much extra you repay. Patience is key, and regular reviews can ensure your strategy remains effective.