In a nutshell, debt recycling is simply borrowing money to invest but with a twist. The twist is that it’s a system that allows you to replace your ‘bad debt’ with ‘good debt’.
‘Good debt’ and ‘bad debt’ are terms coined by Robert Kiyosaki, author of the bestselling finance book, ‘Rich Dad Poor Dad’. Kiyosaki refers to ‘bad debt’ as debt that you cannot claim the interest you pay on it as a tax deduction. For example, home loans and personal loans. Naturally, this is also debt we want to pay off quickly.
‘Good debt’, on the other hand, is debt used for investing in assets such as property (both residential and commercial) and shares. Shares can be those purchased on the stock exchange via a broker or by an investment manager on your behalf (managed funds). This type of debt is considered ‘good’ because any accumulated interest on the amount of money borrowed is tax-deductible.
So how do you use debt recycling to reduce your ‘bad’ debt?
The idea behind debt recycling is to use the reduction of the principal amount in your home loan to redraw from and to put that money into investments that produce capital growth and income, such as dividends or rents. The income derived from such investments can then be used to pay down your home loan – to reduce that ‘bad debt’ as it were.
For example, if you were to pay $500 a week off your $400,000 home loan home with an interest rate of 2.75 per cent per annum, you would be able to redraw around $6,000 after one year of those home loan repayments. While this amount ($6,000) is not enough to purchase an investment property, it would allow you to buy shares or purchase property via a managed investment fund.
A good financial adviser will ensure that the investments for this purpose produce a good income as well as capital growth over time. Any income derived from your investment is then funnelled back into your mortgage, and while you may be starting small, over time this income grows, and you’ll see an obvious reduction to the principal amount of your home loan.
I can say with utmost confidence that we all want to put ourselves in a better financial position. Debt recycling enables you to pay more off your home loan each year while slowly, but surely building an investment portfolio that will grow over time. The beauty of this strategy is that, if set up correctly, there’s little to no impact on your cash flow.
Additionally, it’s a fair assumption that the value of your home will increase over time. This provides the opportunity to use the equity between the growth in your home value and your home loan amount for further investment purposes (i.e., purchasing a commercial or residential investment property).
You can read more about this in our article “using equity to buy a second home”
Obviously borrowing to invest is not without certain risks which is why seeking expert advice is highly recommended. A good adviser will help negate the associated risks. They will also ensure that all financial strategies are tailored to your individual circumstances.
We look forward to the opportunity of helping you turn your ‘bad debt’ into ‘good debt’.
Director and Financial Adviser
Strategic Invest Blue
*Todd Burrows has been a leading financial adviser in Hobart for more than 25 years and is the founding partner of Strategic Financial Planning (recently rebranded to Strategic Invest Blue).
At Strategic Invest Blue we’re dedicated to providing holistic advice to our clients, be it young families, empty nesters or retirees so that they can live their best possible lives.
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What you need to know
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