27 Oct Should you consider debt recycling?
Debt recycling is a clever way for investors to use debt while also maximising their tax benefits.
At its core debt recycling involves redirecting your debt from non-tax-deductible sources, such as your mortgage, towards something that is tax-deductible such as an investment property.
For property investors, this works by tapping into the equity in your home, usually by obtaining a new loan secured against your property. Then taking the borrowed funds and using them to purchase an investment property.
The important aspect is that the new investment loan should be tax-deductible, meaning the interest payments on this loan can be offset against your salary. This effectively reduces your taxable income.
The income generated from your investments is then used to pay down your non-tax-deductible debt which is your home loan.
Over time, both your home and investment assets are expected to appreciate in value. This capital growth can be used to further reduce your non-deductible debt. Ultimately, the goal is to transition your debt entirely from non-deductible sources like your home loan to deductible investments.
As your investment portfolio grows, you can extract any increased equity and use it to pay down your home loan or acquire additional investments.
This becomes easier to understand when we look at an example.
Let’s say Michelle and Nick own a home valued at $1,200,000 with a remaining home loan balance of $500,000.
That means their current equity is $700,000.
They take out a $300,000 loan using the equity in their home to purchase an investment property worth $1,000,000.
Income generated from the investment property is then used to pay off their home loan.
They claim tax deductions on their investment loan interest, reducing their overall tax liability. As both the home and investment property values increase, they can continue to draw equity to invest and pay down their owner-occupied loan and eventually pay off their home loan.
It’s also possible to use the concept of debt recycling and apply it to your credit card and offset account.
Start by taking any income you receive including wages, bonuses and other lump sums and deposit them into an offset account. At the same time, you then pay for all your living expenses with your credit card.
Then you simply make sure the credit card balance is paid off in full each month before interest accrues. However, by keeping as much money in the offset account as possible, the outstanding mortgage balance effectively decreases as you are saving interest.
For example, with a mortgage balance of $400,000 and $40,000 in the offset account, interest is calculated on only $360,000 – saving you money.
Debt recycling is a clever way to save interest and minimise your tax liability. Be sure to speak to a professional to make sure this strategy is right for your personal situation.
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