Debt Recycling. How does it work, and can it help you get ahead?
For more information on good debt, bad debt, debt recycling and what does it all mean, click here.
How does the Strategy work?
Traditional debt management and wealth creation strategies focus on paying off the home loan as quickly as possible by increasing the frequency and amount of the repayments. Once the home is repaid the wealth creation process commences, using the previous loan repayments to purchase investments.
Conversely, debt recycling strategies allow you to start investing for the future now whilst continuing to pay off your home loan. Cash flow freed up, using traditional debt management strategies, is used to service an investment loan. All additional income (i.e. dividends, tax savings, surplus cashflow) is paid off the home loan and periodically redrawn and added to the investment. Over time, the non-deductible (bad) debt is converted to deductable (good) debt, hence the term debt recycling.
The borrowed funds are invested into diversified portfolio assets, generally with a bias towards investments that will provide regular distributions and tax benefits.
For this strategy to work, there are a few things you need:
- A regular, independent income that will deliver a surplus of cash flow to cover interest payments on the loan.
- A long-term investment focus.
- Readiness to increase debt to hold an investment loan.
- Risk tolerance.
- Income protection insurance.
- Consolidate debts into a new loan to release cash flow.
- Consider making home loan interest only to free up maximum cash flow (depending on your risk tolerance).
- Consider borrowing a lump sum to invest (e.g., $100,000).
- Direct all income from investments and tax savings into the home loan as well as any additional surpluses like bonuses, pay rises etc.
- Regularly (monthly if possible) redraw funds that have been repaid into the home loan and add to the investment portfolio.
- Once all debt is converted to deductable debt, the dividends and tax savings can be deposited into the investments.
Taking Advantage of Low-Interest Rates
If you’re looking to refinance, take out a new loan or buy your first property, there has never been a better time to lock in with interest rates at a historic, record low. In the midst of the Coronavirus pandemic, the Reserve Bank of Australia (RBA) set the cash rate at an all-time low of 0.25%, to help stimulate the economy and prevent a looming recession. For the last 20 years we have seen the average cash rate sitting at 5.1% (i) The highest rate for this period was in 2008 where we saw interest rates sitting at 7.25%. They have been relatively stable for the last three years sitting on 1.5% until more recent quarters when the RBA began to cut rates.
Keep in mind the cash rate is the rate between bank to bank, so what the RBA passes onto the banks. It is up to the bank whether they pass on the discount to their customers which is why it’s always worth shopping around for the perfect loan. Most banks then charge a commission rate between 2-3% on top of the cash rate.
If your mortgage rate is currently over 3% speak to our banking and lending team, to see if we can help you save through refinancing.
For more information on how you can make the most of low-interest rates, click here.
Considering Debt Recycling?
Of course, debt recycling isn’t suitable for everyone. If you’re considering this strategy, it’s important to understand all the risks involved. Seeking financial advice may help you to determine if this strategy is right for you.
At Invest Blue, we have an incredible in-house banking and lending team who can help you find the right loan and lender to complement your individual circumstance. We will guide you through your loan search to secure the right loan for your needs to completion of your loan and beyond.
Want more information and an example?
Contact us today for a complimentary initial consultation.
What you need to know
This information is provided by Invest Blue Pty Ltd (ABN 91 100 874 744). The information contained in this article is of general nature only and does not take into account the objectives, financial situation or needs of any particular person. Therefore, before making any decision, you should consider the appropriateness of the advice with regards to those matters and seek personal financial, tax and/or legal advice prior to acting on this information. Read our Financial Services Guide for information about our services, including the fees and other benefits that AMP companies and their representatives may receive in relations to products and services provided to you.
i) RBA rates history https://www.marketindex.com.au/rba-cash-rate