Is debt recycling right for you?

Debt recycling is a three-tiered financial strategy. That is, it aims to reduce your home loan, minimise your tax liability and generate future wealth. It differs from traditional debt management, which ultimately focuses solely on reducing the existing loan without looking at investment strategies.

Debt recycling, on the other hand, involves using your current home loan equity to invest in other opportunities.

How debt recycling works

So how does it work? It’s all about creating a cycle of turning ‘bad’ debt into ‘good’ debt. An investment loan is set up with your existing free cash flow. Investment assets typically include shares and property that can provide good tax returns. Any additional income received from that investment (such as dividends, tax savings or windfalls) is used to reduce the home loan balance. Then every so often, the home loan is redrawn and the amount added to the investment portfolio.

Over time, you’ll notice that as the home loan reduces, the investment assets will grow – leading to debt recycling.

What are the benefits?

The benefits of debt recycling include the ability to pay off your home loan sooner. You can also potentially save home loan interest and tax each year, while creating future wealth. And you can do all this by maintaining your current lifestyle.

Sounds great – but how do I free up my cash flow?

A good way to free up existing cash flow is to consolidate your debts. You can do this with either a balance-transfer credit card or a debt-consolidation personal loan, depending on the amount of your debt.

Another way to free up cash flow is to refinance your home loan as an interest-only loan. This does however have financial implications, so you should always speak with a financial adviser first.

Should you consider it?

Like any investment strategy, there are benefits and risks – and it takes a lot of commitment to make it work effectively. But with debt recycling, the financial benefits can be quite significant.

If you consider a debt-recycling strategy in action over a 20-year period, you may find that by maintaining the same level of debt and converting bad debt to good debt, your investment loan may create wealth far in excess of that created through traditional debt-management strategies.

Debt recycling is definitely something to consider, but it’s worth speaking to a financial adviser to find out how to make it work best for you.