Debt recycling is a financial strategy that is designed to help pay off your home loan sooner.
It involves replacing or ‘recycling’ bad debt with tax-deductible good debt from investments. while also building wealth in a tax-effective manner over the longer term. Let's take a closer look at how this actually works and the considerations that need to be made before deploying a debt recycling strategy.
What is ‘good debt’ and ‘bad debt’? What does it mean? Put simply, good debt is debt you take on for investment purposes. You are aiming to grow these investments over time, and the interest rate charged on the good debt is generally tax-deductible. This means there is a tax advantage with this debt as the interest costs can reduce the amount of tax you pay.
On the other hand, ‘bad debt’ is debt for which there are no tax advantages. The interest payments are made with your after-tax income. Common examples of bad debt are credit cards and car loans. There is one other form of debt, and it is generally the most common form: mortgage debt over your home. While strictly speaking, mortgage debt is ‘bad debt’, because you do not receive tax advantages for the debt, it is also beneficial as it allows you to purchase an asset, such as your home, that is expected to grow over time.
We all know the value of making additional home loan repayments. Additional loan repayments reduce the loan and can save interest costs in the long run. Essentially what you are doing is reducing the level of bad debt you hold. As you reduce the bad debt you could replace it (i.e. recycle) with good debt.
As you pay down your home loan you are creating equity in your home because the portion of the home you own is increasing, while the value the bank owns (i.e. your mortgage) is decreasing. As your equity position increases you could consider drawing on this equity for investment purposes.
Benefits of debt recycling can include:
Debt recycling involves the use of debt to grow wealth. As a result, there are a number of risks to consider before undertaking this strategy:
If you are interested in discussing a debt recycling strategy with a financial adviser please contact us HERE.
Hewison Private Wealth is a Melbourne based independent financial planning firm. Our financial advisers are highly qualified wealth managers and specialise in self managed super funds (SMSF), financial planning, retirement planning advice and investment portfolio management. If you would like to speak to a financial adviser on how you can secure your financial future please contact us 03 8548 4800, email email@example.com or visit www.hewison.com.au
Please note: The advice provided above is general information only and individuals should seek specialised advice from a qualified financial advisor. The views in this blog are those of the individual and may not represent the general opinion of the firm. Please contact Hewison Private Wealth for more information.