Debt Recycling Australia: How to Pay Off Your Home Loan Faster and Build Wealth

Are you seeking ways to expedite your mortgage repayment and build wealth simultaneously? Consider leveraging the unique financial strategy known as debt recycling. Widely adopted in Australia, this innovative tactic involves restructuring your existing debt to generate additional investment funds. 

Let’s delve into the concept of debt recycling and how it can help you pay off your home loan faster and increase your wealth in Australia.

What is Debt Recycling Strategy?

Debt recycling is a strategy that can help you pay off your non-deductible debt (e.g. your home loan) as quickly as possible, while also building up your wealth in a tax-effective way over the longer term.

It works by using the tax benefits of investment property to offset the interest on your non-deductible debt. For example, if you have a $500,000 home loan with an interest rate of 5%, and you invest in an investment property that generates $20,000 in annual rental income, you could use the rental income to offset the interest on your home loan. This would save you $25,000 in interest payments over the course of the loan.

In addition to saving you money on interest, debt recycling can also help you build wealth faster. This is because the money that you would have otherwise used to pay off your home loan can be invested in an investment property, which has the potential to grow in value over time.

Of course, debt recycling is not without its risks. One of the biggest risks is that you could end up with more debt than you can afford. Another risk is that the value of your investment property could decrease, which would reduce the amount of tax benefits that you can claim.

Debt recycling is not a get-rich-quick scheme. It’s a long-term strategy that requires careful planning, disciplined execution, and patience. 

Let’s unravel this process step by step.

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The Process of Debt Recycling

Here’s a breakdown of the process of debt recycling:

Step 1: Take Out a Home Loan

The initial step in the process of debt recycling involves taking out a mortgage for a home purchase. This loan is considered “bad debt” as the interest on your mortgage is not tax-deductible.

Step 2: Repay Your Mortgage and Build Equity

With your mortgage in place, you begin making repayments. Over time, as you pay down the loan, you are simultaneously building equity in your home. Equity refers to the portion of your home that you truly own, meaning the part you’ve already paid off.

Step 3: Leverage Home Equity for Investment

Once you’ve accumulated a decent amount of equity, you can utilise this capital for investment. This can be achieved either through a line of credit, where your home acts as collateral, or by redrawing on your mortgage, thereby increasing the size of your loan.

Step 4: Invest in Income-Generating Assets

The funds borrowed against your home equity should be invested in income-generating assets, such as shares, managed funds, or other similar investments. The goal here is to achieve a return on investment that outweighs the interest charged on your borrowed funds.

Step 5: Use Investment Income for Mortgage Repayment

The income you generate from your investments can then be used to make additional repayments on your mortgage. This process accelerates your home loan repayment and helps in reducing the “bad debt” quicker.

Step 6: Shift 'Bad Debt' to 'Good Debt'

While you are repaying your home loan faster with the investment income, the debt related to your investments is considered “good debt”. This is because the interest on the borrowed money for these investments is tax-deductible, which is not the case with your home loan interest.

Step 7: Repeat the Process

Finally, this process can be repeated — continuously drawing on the equity for investment and using the returns for mortgage repayment — to maximise your financial growth and tax efficiency. Over time, this recycling of debt will result in a growing investment portfolio while your home loan diminishes, effectively serving the dual purpose of debt reduction and wealth creation.

Remember, debt recycling requires careful planning, discipline in execution, and a patient approach, as it’s designed as a long-term wealth-building strategy.

Debt Recycling Example

Let’s delve into an example to illustrate how debt recycling works:

  • Initial Mortgage: Let’s say you have a home loan of $500,000 at an interest rate of 3% per annum. You are diligently making repayments and have built up $100,000 in equity.
  • Leverage Equity: Next, you decide to draw on this equity for investment. You take out an investment loan of $100,000 against your home equity, which is also at an interest rate of 3% per annum.
  • Investment: You invest these funds in income-generating assets such as shares or managed funds. Let’s assume that these investments are generating an annual return of 7%.
  • Income Generation: Over the year, your $100,000 investment generates $7,000.
  • Reinvest in Mortgage: You decide to use this $7,000 to make additional repayments on your mortgage, thereby accelerating your home loan repayment.
  • Tax Deductions: Meanwhile, the interest on your investment loan ($3,000 in this example) is tax-deductible because it’s being used to generate income.
  • Repeat: As your home loan reduces and your equity increases, you can repeat the process, borrowing against the increased equity to invest more.

Please note that this is a simplified example and does not take into account various factors like taxes, fees, potential changes in interest rates, or fluctuations in investment returns. Also, the example assumes a positive return on investment, which might not always be the case. It is always advised to seek professional financial advice before implementing a strategy like debt recycling.

Debt Recycling Investment Property

Incorporating investment properties into a debt recycling strategy can indeed create an effective wealth-building mechanism. Here’s how it can work:

  • Initial Home Loan: Let’s assume you have a home loan of $500,000 with an interest rate of 3% per annum. You’ve been consistently making repayments, and now you’ve built up $100,000 in equity.
  • Equity Leveraging: You decide to tap into this equity and borrow $100,000. This loan will have a similar interest rate to your home loan.
  • Property Investment: Instead of investing in shares or managed funds, you decide to invest this $100,000 as a down payment on an investment property. Let’s assume the property costs $500,000, and you secure a loan for the remaining $400,000.
  • Rental Income: You rent out the property and start earning rental income. Let’s assume the property yields a 4% rental return per annum, amounting to $20,000.
  • Mortgage Repayment: You use this rental income to make additional repayments on your home loan, helping to accelerate the repayment process.
  • Tax Deductions: The interest on your investment property loan is tax-deductible, as it’s used for income-generating purposes.
  • Property Value Appreciation: Over time, if your investment property appreciates in value, you can access the increased equity to invest further, keeping the cycle going.

However, it’s important to note that investing in property comes with its own risks and considerations. These include property management costs, potential periods without tenants, property market fluctuations, and higher transaction costs compared to other investments.

Like with all financial strategies, it’s recommended to seek professional advice before implementing debt recycling with investment properties. The strategy should align with your financial goals, risk tolerance, and overall investment plan.

Pros of Debt Recycling

Debt recycling offers several advantages:

  • Accelerated Mortgage Repayment: The additional income generated from the investments can be put towards paying down your mortgage faster.
  • Wealth Creation: Over time, your investment portfolio grows, creating a long-term wealth-building strategy that functions alongside your regular income.
  • Tax Efficiency: The interest on the loan used for investments is tax-deductible. This aspect could potentially reduce your tax burden while freeing up more money to repay your mortgage or invest further.

Cons of Debt Recycling

Here are some cons of debt recycling:

  • Market fluctuations: Debt recycling often involves investing in the share market, which is subject to market fluctuations. This means that there is a risk of losing money on your investments.
  • Interest rate risk: Debt recycling involves borrowing money to invest. If interest rates rise, the cost of servicing your investment loan could increase, which could reduce your investment returns.
  • Complex financial management: Debt recycling requires a deep understanding of financial management, tax laws, and investment strategies. If you don’t have a comprehensive understanding of these areas, you could end up extending your debt period or even facing a financial crisis.
  • Lack of liquidity: Debt recycling can reduce your liquidity, as you will have less cash available to meet unexpected expenses.
  • Risk of overleveraging: Debt recycling can increase your debt levels, which could put you at risk of financial hardship if you lose your job or if there is a market downturn.

Who Can Benefit From Debt Recycling?

Debt recycling may be an ideal strategy for:

  • Individuals with a substantial home mortgage and a high level of discipline in financial management.
  • Those with a robust income source that allows for consistent mortgage repayments and investment contributions.
  • People with a sound understanding of investment risks and an appetite for long-term financial strategies.

However, debt recycling is not for everyone. Consult with a financial advisor to evaluate whether this strategy aligns with your financial goals, risk tolerance, and personal circumstances.

Wrapping Up

Debt recycling is a powerful financial strategy that can help you pay off your home loan faster and build wealth in Australia. It’s a viable approach that offers tax advantages and enables parallel paths for debt reduction and wealth creation.

However, like any other financial strategy, it requires an informed decision, comprehensive understanding, and meticulous management. Make sure you assess the risks, seek professional advice, and plan for contingencies to optimise your financial future.

Remember that every financial journey is unique, and what works for one may not necessarily work for others. Therefore, embrace the financial strategy that best caters to your financial situation, goals, and risk tolerance. With the right planning and execution, debt recycling could serve as a transformative financial tool, leading you towards a future of financial freedom and security.

Invest with Odin Mortgage

Investing with Odin Mortgage can be a good option for those who are looking to invest in the Australian property market. 

We specialise in helping Australian expats and foreigners buy property in Australia. We have a team of experienced mortgage brokers who can help you find the right property for your investment goals and secure a competitive mortgage.

Talk to our mortgage brokers at Odin Mortgage to discuss your investment options. We will be able to help you create a personalised investment plan that meets your individual needs and goals.

Contact us today.

Get a free Australian mortgage assessment today.

Apply online to get a free recommendation with real rates and repayments.

Frequently asked questions

The debt recycling method is a strategy used by individuals to convert non-tax-deductible debt, such as a home mortgage, into tax-deductible debt, such as an investment loan. It involves using the equity in a property to invest in income-generating assets, such as shares or investment properties. 

The income generated from these investments is then used to pay down the non-tax-deductible debt, while the tax-deductible debt remains. This strategy aims to maximise tax benefits and wealth accumulation over the long term.

Debt cycling is another term that refers to the debt recycling method. It involves the process of converting non-tax-deductible debt into tax-deductible debt, as explained above, with the goal of reducing non-tax-deductible debt while simultaneously building wealth through investments.

Offset and redraw are two different features offered by some mortgage products that can be used in debt recycling strategies.

Both offset and redraw facilities can be utilised in debt recycling, but they work differently. Offset accounts reduce the interest paid on the mortgage, while redraw facilities allow you to access extra repayments you have made.

In Australia, a tax deductible debt refers to a debt on which the interest payments are eligible for a tax deduction. The interest expenses incurred on certain types of debts can be claimed as a deduction against taxable income, reducing the overall tax liability. 

Examples of tax-deductible debts in Australia include investment loans, such as loans taken to acquire shares, rental properties, or other income-generating assets. 

On the other hand, non-tax-deductible debts, such as personal loans or home mortgages for owner-occupied properties, do not qualify for tax deductions on the interest payments.

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