How does debt recycling work?

Debt recycling may be a little confusing, so let’s explain it with a seven-step guide.


1. Over time you will have paid down a portion of your home mortgage with a principal and interest loan and during that time your home would have increased in value.

The difference between the current value of your home and the outstanding amount on your mortgage is your equity.

2. The bank will often lend you up to 80% of the value of your home as long as you can show serviceability.

3. You would take out a new investment loan using your available home equity as security and the purpose of this loan would be to use the funds as a deposit on an investment property.

Imagine your home is worth $600,000 and your available equity is $300,000 because you’d paid your mortgage down to $300,000.

You could recycle $150,000 of this equity as a loan – in other words, take out a new investment loan for $150,000 which would be then used as a deposit for an investment property, using the equity in your home as security.

This would leave you with a loan to value ratio of 75% ($450,000 loan on a $600,000 property) well within banks lending parameters.

4. You could use this $150,000 to invest in assets that produce both income and capital growth such as a managed fund, shares, or as the deposit against an investment property.

5. You could even use the income generated from your investments, plus any tax advantages of a geared investment, to pay off the non-deductible debt in your home loan.

6. Over time you will build your wealth as your investment property or share portfolio should increase in value over time and the cash flow you receive in the form of rental or dividends should also increase.

7. At the same time you will slowly be paying down the mortgage on your home, so that when you reach your retirement years and start enjoying the longest holiday you will have in your life, you will own your own home with no debt and have an investment portfolio of properties or shares (preferably both) with a manageable level of debt.

In order for a debt recycling strategy to work you need the following:

·A regular, independent income you can rely on to deliver a surplus cash flow to cover the interest payments on your investment loan.

·A long-term investment focus.

·A willingness to increase your debt and hold an investment loan.

·Tolerance for risk and short-term fluctuations in investment value.

·Income protection insurance—it may provide replacement income in case you’re sick or injured and unable to work.

·And the financial rainy day, cash flow buffer to see you through the ups and downs of your property investment journey – this could be in the form of money in an offset account

So now that you understand a little more about debt recycling, you can see that good debt isn’t really a problem – in fact, you can be an asset.


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Jason Gwerder
Thursday, 18 March 2021

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