Debt Recycling is an interesting concept, which if implemented correctly can add large value to your investment portfolio.
Let’s Discuss it in this blog article. Heard about good debt or bad debt?
Let’s look at a typical scenario, Mr. Joe Blogs with a home loan on principal & interest repayments, slowly chipping away at reducing debt slowly over time.
He could consider the Debt Recycling strategy which aims to convert non-deductible debt (like your home loan on primary residence) into deductible debt (like property or shares) with the aim to help you pay off your non-deductible debt (eg your home loan) as quickly as possible, while also building up your wealth in a tax-effective way over the longer term.
If Mr. Joe Blogs could reborrow off the home loan and invest in other assets like shares or investment property, let’s say at a 4% interest rate, returning 4% (rent or dividends) then the interest he paid is deductible against the income from the investment. If the investment earns more than 4% pa then you would be in front and the extra money received could then be used to pay down the bad debt even faster.
Most properties generally have negative cash flow so a property owner generally has to hang onto the property for a few years and then sell and use the proceeds to pay down the bad debt and then reborrow (debt recycling).
Further reduction in bad debt would potentially mean more funds are available to be borrowed to invest. This, in turn, would potentially lead to more income to pay off the bad debt which could then be turned into good debt by borrowing again to invest.
If debt recycling is all managed well with the help of specialists you could end up with bad debt eliminated & left with deductible good debt.
Please speak to a licensed financial planner & a tax accountant to decide if this strategy is appropriate to your needs.
Carefully planned, debt recycling can get you where you want to go sooner.
Pardeep (Paddy) Boyal is managing director of South East Wealth practising mortgage broker & was a licensed financial adviser. E: paddy.boyal@southeastwealth.com.au or visit www.southeastwealth.com.au M: 0420 589 194
Benefits of Debt Recycling:
- Help give your income a boost
- Tax effective as capital gains are taxed at half the rate of income earned
- Can be even more tax effective with tax planning
- Can pay down non-deductible debt much quicker
- Improves serviceability because non-deductible debt is decreasing
- Improves cash flow as less tax is paid and therefore more cash in your pockets
- You are not paying more tax, but just bringing it forward
- Small capital gains are easier to plan for and reduce tax (or eliminate it)
Cons of Debt Recycling:
- Eats up serviceability (until you sell an asset)
- If lenders change serviceability rules in the future you may not be able to borrow to replace the property sold.
- It may be better to keep holding, avoid the transaction costs, and have a larger capital base to keep growing
- Transaction costs can be in the range of 10% of the property value each time you buy & sell.
Disclaimer: – Articles in this blog are just the personal opinions of the author or authors.
It may or may not be correct. Pls do your own due diligence and pls seek professional advice according to your own personal circumstances. The author or authors cannot be held responsible/liable for any content in this blog.
