The concept of debt recycling appears regularly as an investment strategy so let’s take a look at what this actually means.
What is debt recycling?
Debt recycling is a strategy designed to help you pay off your non-deductible debt (e.g., your mortgage) while also building wealth through tax-deductible investments at the same time. In essence, debt recycling involves replacing or “recycling” the debt in your home loan with tax-deductible debt used for investments.
How does it work?
Using debt recycling effectively means taking equity from your home and investing it somewhere else - with the “somewhere else” being investments that provide the potential for increased income and growth. The strategy revolves around the income from these new investments being used to pay down your mortgage while the growth from the investments contributes to wealth accumulation. All surplus cash flow, after the interest is paid on the investment loan, is used to reduce a non-deductible home loan, thereby more rapidly increasing equity in the home. As equity in your home increases, you can make additional drawn downs to then invest in further investments. In addition, because the interest on investment home loans is typically tax-deductible, debt recycling also creates the potential for tax-savings that can then be used towards your home loan.
What are the risks?
Debt recycling is considered a high-risk strategy because it involves gearing, i.e., using borrowed money to invest, and you are using your own home to secure that debt. If interest rates increase or your investment doesn’t perform as expected, this could create significant financial stress.
In addition, during times of market downturn, debt recycling can lead to compounding losses - and the interest rates for investment loan facilities can be higher than standard variable mortgage rates.
You will also need to consider your life insurance cover to ensure the increased debt levels are provisioned for if your income stops because of death or illness.
Is it for me?
Debt recycling won’t be suitable for everyone, so it is best to speak with your financial adviser to discuss whether this strategy might be appropriate in helping you reach your goals.
Your financial adviser will work with you to understand your circumstances, your appetite for risk (your risk profile) and your investment time frames to help you determine if this an appropriate strategy for you. There are many strategies available to achieve your financial goals so it's important to be aware of your options and understand what will be most suitable for you.
If you would like more information on debt-recycling or have any questions, please contact your financial adviser.