Introducing debt recycling, a strategic financial solution to transform your debt into a valuable asset.
The objective is to generate more income, expedite mortgage repayment, and decrease tax obligations. This approach entails paying off the mortgage, freeing up equity, borrowing the funds again for investment purposes, and replacing non-deductible debt with deductible debt.
As a result, a cycle of repayment and re-borrowing is established – hence the term recycling.
This article examines two scenarios for a client: one employing debt recycling and the other without it, showcasing how debt recycling can produce substantial long-term savings.
Read on to discover how to optimise financial gains while minimising tax liabilities.
Part 1: debt recycling home loan strategy
The client owns a house that he bought five years ago.
The mortgage on his home was $300,000. It’s worth $600,000 five years later with a $250,000 mortgage. Consequently, the home has substantial equity.
He wants to use this equity to buy his forever family home and use his current home as an investment property.
Once he buys the new home, he will have a $250,000 loan on the $600,000 investment property and the new home he bought for $800,000. He will have an $825,000 loan with stamp duty costs there.
The same man who bought his home five years ago decides to sell his home instead. He gets about $335,000 cash from the sale, accounting for agent fees and paying off the loan.
He uses that cash to buy his family home for $800,000. Again, he uses the cash to pay stamp duty and ends up with a $490,000 loan.
Subsequently, he taps into the equity of his recently acquired home and employs it for an additional purchase – an investment property worth around $600,000 after deducting fees. This allows him to choose whatever he desires as his next venture.
It also allows him greater flexibility in choosing the investment property he wants to purchase, including the area and price. The other benefit of this is that that investment loan is deductible debt. Now, his home loan is non-deductible.
In scenario one, the man is stuck with what he’s got.
In scenario two, he has a much smaller home loan and a bigger investment loan which is tax deductible, whereas, in scenario one, he has a much higher home loan which isn’t tax deductible.
Part 2: Debt recycling tax deductions
In scenario one, the man will receive a tax deduction worth about $16,000 on his tax return, assuming a 6.5% interest rate on his investment loan. With a marginal tax rate of 34.5he can enjoy a tax saving of roughly $5,500.
In the second scenario, he will receive a tax deduction of $39,000 being the interest on his higher investment loan, resulting in $13,500 in tax savings (keep in mind that he’s also paying much less interest on his home loan). This debt strategy provides an improvement of approximately $8,000 per year.
However, additional costs include transaction fees of around $40,000 when buying and selling a property as an agent. Moreover, there are fees of 2.5% on the $600,000 loan and approximately $15,000 for the home.
Stamp duty on the $800,000 house also amounts to about $25,000. With this strategy, it would take approximately five years to recover the initial investment of $40,000.[P1]
However, there are additional costs in the 2nd scenario. These include agent fees on selling his first house and stamp duty on rebuying the new investment property. This works out to additional costs of about $40,000, which is recouped over 5 years.
Case study on debt recycling
The moral of this story is to invest for the long term and to minimise your non-tax deductible debt first. In this person’s case, the goal now will be to direct all surplus cash flow plus tax returns into their home loan and do all future investing using borrowed funds.
At some point in time, when the home loan is repaid, they may start investing surplus cash flow, paying down the tax-deductible debt or even start contributing that surplus to superannuation.
Seeking financial advice from Precision Wealth Management will help you make the best-informed decision, saving you money and acquiring the freedom you deserve.
If you want to look at a debt recycling strategy or talk about other investment options, please get in touch with Precision Wealth Management today.
Precision Wealth Management is a local, privately-owned financial planning firm based on Brisbane’s northside.
Our certified advisors work with each individual client to determine the best wealth creation strategy based on their unique situation.
We strive to stay at the forefront of the industry, and our investment approach is based on decades of research.
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