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Save on Tax and Pay Off Your Home Faster with Debt Recycling in Australia

Published 16/09/2024 | Last Updated 16/09/2024

Written by:
Joel Simmonds
Head of Advice  

Debt recycling might sound complicated, but it’s actually a straightforward strategy that can help you use your home loan to build wealth.

In simple terms, debt recycling in Australia means turning non-tax-deductible debt, like your mortgage, into tax-deductible debt that you can claim on your tax return. By doing this, you can start investing, pay off your home loan quicker, and potentially save on tax.

Read on as we explain how you can use debt recycling to your advantage. 

Table of Contents

How Does Debt Recycling Work?

Debt recycling works by taking equity from your home loan and investing it in income-producing assets like shares or an investment property.

You then use the income from those investments to pay off your mortgage faster. Over time, your home loan shrinks, and you’re left with tax-deductible debt on your investments.

To give an example of debt recycling, let’s say you’ve paid off a good chunk of your mortgage and have built up $200,000 in equity. You can borrow against that equity to buy shares or invest in property. The interest on this loan is tax-deductible, and the returns from the investment help you pay off your home loan quicker.

Here's a Simple Example of Debt Recycling

Imagine Peter and Michelle, a couple who’ve been paying off their mortgage for several years. They’ve built $300,000 of equity in their home.

They decide to use debt recycling by borrowing $150,000 from their home loan to buy shares. The interest on the loan is tax-deductible, and they use the dividends and tax savings to pay down their mortgage faster.

Over time, they’ve turned their non-tax-deductible home loan into an investment loan that offers tax benefits.

What Are the Benefits of Debt Recycling?

When incorporated into a well-structured financial plan, debt recycling can help reduce the costs of holding investments.

Some of the benefits include:

  • Paying off your home loan faster by using investment income.
  • Saving on tax because the interest on your investment loan is tax-deductible.
  • Building wealth by diversifying into assets like shares or property.
  • Not sacrificing your lifestyle since you’re using the returns from your investments to cover your mortgage.

Debt recycling can be particularly beneficial if you have a solid income and a long-term investment mindset.

Risks of Debt Recycling

Like any financial strategy, there are pros and cons of debt recycling. 

The main risk is that you’re borrowing more, which could become difficult to manage if interest rates rise or your investments underperform. 

You’re also reliant on maintaining steady income to cover both your home loan and the debt recycling loan structure.

Tax Benefits of Debt Recycling

One of the key benefits of debt recycling is that the interest on an investment loan is tax-deductible. 

However, it’s important to understand that claiming the interest doesn’t result in a 100% refund. Instead, the amount you save depends on your marginal tax rate.

For example, if you’re in the 37% tax bracket and claim $10,000 in interest, you would save $3,700 in taxes (37% of the interest amount). This means you reduce your taxable income, but you won’t receive the full interest amount back.

In-depth Debt Recycling Example

Debt recycling can be an effective strategy for those looking to pay off their home faster while building wealth through investments. 

Debt recycling is a strategy designed to help individuals pay off their home faster while growing their investment portfolio. In this example, we’ll look at how debt recycling could work in a scenario where the individual has a salary of $180,000 and a $750,000 mortgage. Over a 10-year period, this example shows how the strategy may lead to potential long-term financial benefits.

  • Salary: $180,000
  • Initial Investment Amount: $150,000
  • Annual Investment Amount: $65,000
  • Mortgage: $750,000
  • Current Mortgage Interest Rate: 5.99% (potential to drop to 3-4%)
  • Dividend Return Rate: 3%
  • Capital Growth Rate: 5.4%
  • Duration: 10 years
  • Assumed marginal tax rate: 45%

1st Year Results Comparison

Without Debt Recycling:

  • Amount Invested: $150,000.00
  • Dividend Return: $4,500.00
  • Tax on Dividends: $2,025.00
  • Tax-Deductible Interest: $0.00
  • Tax Savings: $0.00

With Debt Recycling (at 5.99% interest):

  • Amount Invested: $150,000.00
  • Dividend Return: $4,500.00
  • Tax on Dividends: $2,025.00
  • Tax-Deductible Interest: $44,925.00
  • Tax Savings: $20,216.25

Yearly Breakdown (at 5.99%)

Total Benefit Over 10 Years (at 5.99%)

By implementing a debt recycling strategy at an interest rate of 5.99%, this example demonstrates how significant financial benefits might be realised over a 10-year period. The strategy could result in total tax savings of $165,754.35 through the conversion of home loan debt into tax-deductible investment debt.

Additionally, potential interest savings of $125,831.99 could be achieved by using investment income and tax savings to pay down the non-deductible mortgage faster.

In total, the example shows an overall benefit of $291,586.34, illustrating how debt recycling can be an effective tool to reduce costs and build wealth more efficiently over time.

What Happens If Interest Rates Drop to 3-4%?

  • Reduced Tax-Deductible Interest: If interest rates drop, the tax-deductible interest on the investment loan would decrease. While this results in fewer tax savings (due to paying less interest), overall interest payments would be lower.
  • Lower Non-Deductible Interest: A reduction in mortgage interest rates would lead to lower interest payments on non-deductible debt (the home loan). This could increase cash flow, which may be reinvested or used to reduce the mortgage more quickly.
  • Potential for Faster Repayments: With lower interest rates, a greater portion of payments would go toward reducing the principal of the home loan. This may result in faster debt repayment while still benefiting from the tax-deductible interest on the investment loan.

How Is Interest Calculated When You Split Your Home Loan for Debt Recycling?

When you split your home loan for the purposes of debt recycling, the interest is calculated separately for each portion of the loan.

The total interest you’ll pay remains comparable to what you would pay if you hadn’t split the loan. Here’s how it works:

  1. First Loan Portion (Owner-Occupied Loan): This is the portion of your loan tied to your home (such as the 20% deposit). The interest on this portion remains non-deductible because it relates to your primary residence.

  2. Second Loan Portion (Investment Loan): This is the amount you’ve split off for investment purposes. The interest on this portion is tax-deductible because it’s used for an income-generating investment.

Interest Calculation:

The interest for each portion of the loan is calculated independently based on the balance and interest rate.

  • Owner-Occupied Loan Interest: Calculated like any standard home loan, and it’s not tax-deductible.
  • Investment Loan Interest: Calculated separately, but this portion is tax-deductible, meaning you can claim it as an expense and reduce your taxable income.

Do You Pay More Interest with Debt Recycling?

No, using debt recycling doesn’t mean you’ll pay more interest. 

The total interest across both loans would be comparable to what you’d pay if you kept the loan whole, but with an added tax benefit on the investment portion.

The key difference is that splitting the loan allows you to make the interest on the investment portion tax-deductible, potentially reducing your overall tax liability.

Can You Use Debt Recycling for Investments You Already Own?

Debt recycling works best when you’re borrowing money to invest in new income-generating assets.

However, if you already own investments, you generally cannot use debt recycling to retroactively make the interest on these investments tax-deductible. Here’s why:

  • New Borrowings: Debt recycling relies on borrowing money to invest, and it’s the new borrowing that allows the interest to be claimed as a tax deduction.
  • Existing Investments: If you already own the investment outright and didn’t borrow money to acquire it, you typically can’t restructure the debt to make the interest tax-deductible. Debt recycling is designed for investments made with new loans.

In some cases, you could sell the investment and repurchase it using borrowed funds, but this may trigger capital gains tax and other costs. It’s important to seek professional advice before considering this option.

Is Debt Recycling Legal?

While debt recycling seems like a cheat code to help you build wealth, it’s actually just a smart strategy that is perfectly legal in Australia.

The ATO allows you to claim interest on investment loans, as long as the borrowed money is used to generate income, such as rent or dividends. 

Make sure to check your loan and investment details to ensure they meet ATO guidelines.

Getting Started with a Debt Recycling Strategy: A Step-by-Step Guide

If you’re keen to explore this strategy, here’s a debt recycling step-by-step process:

  • Build equity: Pay down your mortgage until you’ve built up enough equity.
  • Get investment advice: Speak with a financial advisor or mortgage broker to set up the right structure. Our Investment Advice Services are here to help. 
  • Invest: Use the equity to invest in income-producing assets like shares or property.
  • Pay down your mortgage: Use the investment returns to make extra repayments on your home loan.
  • Repeat: Over time, keep borrowing and investing to recycle your debt until your home loan is paid off.

Tools to Help with Debt Recycling

You can use a debt recycling calculator to figure out how much equity you can tap into and what kind of returns you might expect from your investments. 

Debt recycling calculators available in Australia can also help you determine how quickly you’ll be able to pay off your home loan with this strategy.

Debt Recycling vs Offset Accounts

You might be wondering about debt recycling vs offset accounts. While both can help you pay off your home loan faster, debt recycling offers the added benefit of tax deductions. 

An offset account helps reduce your interest but doesn’t come with the tax perks that debt recycling offers. However, if you prefer a simpler option, offset accounts can be easier to manage.

Debt Recycling vs Negative Gearing

Another comparison to consider is debt recycling vs negative gearing. Negative gearing allows you to claim losses on your investment properties, while debt recycling turns your home loan into an investment loan that offers tax benefits. 

Both can work well in Australia, but debt recycling gives you the added benefit of paying off your home loan faster.

Is Debt Recycling Worth It for You?

If you have stable income, a long-term investment mindset, and are comfortable with risk, debt recycling can be a powerful way to build wealth. 

However, it’s not for everyone. Is debt recycling worth it? That depends on your goals and whether you’re prepared for the risks involved.

We’re here to help you navigate this decision and ensure that debt recycling fits your financial plan. Reach out to our team for expert advice tailored to your situation—together, we can make sure you’re on the right path to achieving your goals.

Click here to learn more about our Investment Advice services.

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Erin provides insights into our investment advice services, explaining how we help you build a tailored investment strategy.

Discover how we align your investments with your financial goals, ensuring a balanced approach that enables growth while carefully managing risk.

FAQs About Debt Recycling

Here’s some of the most commonly asked questions about debt recycling and using it as an investment tool. 

If your questions isn’t answered below, then please feel free to get in touch. We’re always happy to help.

1. What is debt recycling in Australia?

Debt recycling in Australia is a financial strategy that turns non-deductible debt (such as a home loan) into tax-deductible debt by borrowing against your home equity and investing in income-producing assets like shares or property.

2. How do I set up debt recycling?

To set up debt recycling, you’ll need to build equity in your home first. From there, you can borrow against that equity to invest in assets. It’s crucial to consult a financial advisor and ensure your loan structure supports debt recycling.

Make sure you can manage the repayments on both the home loan and the new investment loan.

3. What is a debt recycling spreadsheet?

A debt recycling spreadsheet is a tool used to track the details of your debt recycling strategy. It helps you calculate how much equity you can borrow, what your repayments will be, and how your investments are performing over time.

Many people use spreadsheets to stay on top of their progress and ensure they are meeting their financial goals.

4. What is split loan debt recycling?

Split loan debt recycling refers to dividing your mortgage into two parts: one that covers your home loan and one for the loan used to invest. The split allows you to better manage repayments while keeping track of what portion of your debt is tax-deductible and what isn’t.

5. Can I use debt recycling to buy shares?

Yes, debt recycling can be used to buy shares. When you borrow against your home equity to invest in shares, the interest on that loan becomes tax-deductible.

The income you earn from dividends can then be used to pay off your home loan faster.

5. Can I use debt recycling to buy investment property?

Yes, you can use debt recycling to purchase an investment property. The loan for the investment property is tax-deductible, and any rental income you receive can go toward paying off your home loan more quickly.

This allows you to build wealth while also shrinking your non-deductible debt.

6. What is a debt recycling offset account?

A debt recycling offset account is simply a regular offset account that’s linked to your home loan. It functions like any other offset account by reducing the interest you pay on your home loan.

The difference is that, when combined with a debt recycling strategy, you can use it more effectively. 

While you’re investing borrowed equity into income-producing assets, the money in your offset account works to lower the interest on your non-deductible home loan, helping you pay it off faster.

7. Can I use debt recycling with interest-only loans?

Yes, you can use debt recycling with interest-only loans. This can be an effective strategy as you only pay the interest on your investment loan while focusing on paying off the principal of your home loan. 

However, it’s important to manage your cash flow carefully and consult a financial advisor to ensure this setup works for your financial situation.

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This is a publication of Direct Wealth Pty Ltd, a wholly owned subsidiary of Direct Wealth Group Pty Ltd.

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