In his blog this month Financial Adviser and Mortgage Broker, ROD LINGARD looks into how you can build your property investment portfolio faster by using debt recycling.
Debt recycling is a strategy which aims to turn your current non-deductible home loan into a tax-deductible investment loan.
This involves paying down your mortgage and re-borrowing that money to invest, hence the term ‘recycling’.
A word about tax deductions. What determines whether debt is tax deductible is not the security provided. What matters is what the debt has been used for, or the purpose of the loan.
Generally speaking, if the purpose of the loan is investment, then the interest on the debt may be deductible.
How Does Debt Recycling Work?
Debt recycling involves paying down your home loan, while at the same time, pulling that money back out to use for investing, thereby making that portion of the loan tax deductible.
You then apply to increase your investment loan, or take out a new investment loan, and invest the available funds into income producing assets. Your investments will now generate more income to pay down your home loan. As you continually pay the home loan portion down, you can repeat this process again and again.
Importantly you need to be able to cover the monthly repayment of any new loans from your cashflow sources.
What this means that over time, your overall indebtedness does not shrink, it remails largely the same. This is due to the fact that you are constantly reborrowing that which you have paid down. So, whilst your total debt is not reducing, the non-deductible portion of the debt is decreasing, while the deductible portion is increasing. The other benefit is that you are simultaneously building an investment portfolio.
Sometimes debt recycling is spoken about like a magic way to pay off your home loan and build wealth at the same time. While that can be true, like any strategy that involves investing, there are some risks. Those risks include ensuring you have sufficient income or cash flow to meet the costs of the additional investment loan(s). There is also the risk that the value of the investments may fluctuate over time.
A worked example.
Let’s say you have a home worth $500,000, and a loan of $400,000.
Over the course of the year, you have made your regular payments, plus some additional payments, and at the end of the year you have reduced the balance to $370,000.
You could ‘re borrow’ the $30,000 and use that money for investment purposes. The income from the investment can be directed back to the core home loan.
The process is repeated over time, with the non-deductible home loan reducing, and the investment, and subsequent investment loans increasing.
If you would like an example of how debt recycling might apply to your specific circumstance, please contact me for an obligation free discussion.
Rod Lingard is a Mortgage Broker at Mab Connexion and a Licensed Financial Adviser with Lifestyle Connexion and can be contacted on 0400 160 461. Financial Advice is provided by Rod Lingard – Authorised Representative No: 248734 of MASU Financial Management Pty Ltd | AFS Licence Number 231140 ABN: 78 069 358 498.
Warning: This blog is not designed to replace professional advice. It has been prepared without taking into account your objectives, financial situation or needs. You should consider the appropriateness of the advice, in light of your own objectives, financial situation or needs before making any decision as to whether Superannuation is appropriate for you.