Debt recycling turns non-deductible home loan interest costs into deductible investment interest, providing solid wealth building over time. (Source: Getty/Pivot Wealth)
This young couple were winning on paper but losing in their gut. Both in senior roles, good salaries, owned their own home, and on top had a chunk of shares with their employer.
But underneath, they had a big non-tax-deductible mortgage, a rising tax bill, and a nagging fear that one wrong move could undo years of progress. They felt stuck between strategies, unsure what to do while markets moved around them.
The stress came from wanting to get ahead without sacrificing their lifestyle. The risk of a mistake kept them stuck in the inaction trap, which quietly cost them momentum.
But one smart move changed the script, and got what they already had to work harder. Their lifestyle stayed steady, while their results lifted.
The first thing we did was to reframe their approach. Instead of following the conventional wisdom of paying off your mortgage, then investing, we used the assets they already had to invest now and make their money work harder.
They sold their employer shares strategically, used the fund to clear a large chunk of their home mortgage, and then used one of my favourite strategies to build investments and create tax deductions at the same time.
Debt recycling turns non-deductible home loan interest costs into deductible investment interest, while at the same time you build a share portfolio and another income stream.
The short version is that you pay down your mortgage, and then withdraw the money and invest it into income producing investments like shares and ETFs. The magic of this strategy is that your debt levels stay the same, but over time your interest costs become tax deductible, delivering serious tax savings.
And this all happens while you pay off your home mortgage and build a share portfolio and another income stream at the same time.
There’s no loophole here, because the Australian tax law is built around how borrowed funds are used. Where you show any mortgage redraw went directly into income producing investments, the interest is generally deductible.
The rules are strict on evidence, but the benefits are worth the paperwork.
Worth noting this is a complex strategy with rules you need to be across and get right – it’s not typically a DIY strategy, consider getting some quality professional advice so you get the results you’re after.
If you’re considering a strategy like debt recycling, risk management is critical. (Source: Getty) · Getty Images
To take advantage of this strategy, this couple sold up their employer shares, and combined the proceeds with their existing savings to pay down $400,000 against their home mortgage.
From there, they redrew the exact same amount, but split the loan cleanly for tracking, and invested the money into a diversified ETF portfolio. The redraw went straight from the loan split to the investment account so their paper trail was watertight.
The interest on $400,000 of debt at a 6.5% interest rate was $26,000 yearly. Because these funds were used to invest, all of this interest was deductible – meaning they received an extra $26,000 in tax deductions every year moving forward, giving them over $10,000 extra back in their bank account at tax time.
Put together, the income from the investment portfolio plus the tax deduction almost covered the interest costs, leaving this part of their money almost cash-flow neutral so they could focus their money on paying down their mortgage faster.
Any debt magnifies your outcomes, whether they’re positive or negative. If you’re considering a strategy like debt recycling, risk management is critical.
For this couple, we built a cash buffer initially of three months of income, with a view to increasing that to six months over time. We also carefully considered the ETF investments used with the debt recycling funds, ensuring we had diversification so as to reduce sharemarket risk – rather than chasing single stocks.
We also set up a quarterly review rhythm to look at progress, any deviations, and stay on top of the strategy and risk management into the future.
There are two ways debt recycling can go wrong, and being aware of these before you jump in is all important.
The first is mixing your debt, which impacts deductibility and your reporting. If you draw any funds from your debt and don’t use it for investing, this typically won’t be deductible. If this is mixed in with other tax deductible debt, things can get messy fast.
At best you’ll spend a heap of time trying to unravel everything, at worst you miss deductions.
The second is when you aren’t paying down your non-deductible debt at the same rate you’re drawing from your deductible debt. When this happens, your total debt levels increase – which in turn increases your interest costs and impacts cashflow.
Taken to the extreme, this can impact your ability to fund this strategy moving forward, and mean you have to sell investments in the wrong market conditions.
Both these traps need to be avoided at all costs.
Debt recycling suits households with stable incomes, equity in their home, a long time horizon, and the ability to sit through sharemarket noise.
If you already have savings or investments, that can give you a launchpad to make this work and build traction quickly.
If debt or interest costs keep you up at night, if you’re not saving consistently, and if you don’t have the time to stay on top of your strategy, this may not be the tool for you right now.
Debt recycling worked for this couple because their strategy was solid, they executed well, and they managed their risk. They turned a big mortgage into a lever that helped them get ahead faster, create tax savings, and replace their salary with investment income – and they started getting paid while they were off the clock.
Calling out this is a complex strategy, not a DIY hack. It takes an investment of time and potentially the cost of professional advice, but the results when you get this right pay for this investment many times over.
Ben Nash is a finance expert commentator, podcaster, financial adviser and founder of Pivot Wealth. Ben’s new book, Virgin Millionaire; the step-by-step guide to your first million and beyond is out now on Amazon | Audiobook.
If you want some help with your money and investing, Ben has created a free seven-day challenge you can use to get more out of your money you can join here.
Disclaimer: The information contained in this article is general in nature and does not take into account your personal objectives, financial situation or needs. Therefore, you should consider whether the information is appropriate to your circumstances before acting on it, and where appropriate, seek professional advice from a finance professional.
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