Debt Recycling – What -How & Why?

GENERAL ADVICE WARNING: The information on this site is of a general nature. It does not take your specific needs or circumstances into consideration, so you should look at your own financial position, objectives and requirements and seek financial advice before making any financial decisions.

Heard about good debt bad debt?

Let’s look at a typical scenario, Mr Joe Blogs with a home loan on principal & interest repayments, slowly chipping away reducing debt slowly over time.

He could consider 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 4% interest rate, returning 4% (rent or dividends) then 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 selling and using the proceeds to pay down the bad debt and then reborrowing (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 this is all managed well with the help of specialist you could end up with bad debt eliminated & left with deductible good debt.

Please speak to a licenced 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 this strategy:

  • 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

  • Eats up serviceability (until you sell an asset)
  • If lenders change serviceability rules in 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.

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