Debt recycling is a powerful strategy for those juggling the seemingly competing goals of debt reduction and building an investment portfolio. Many people have a natural instinct to pay off the home first, then consider investing later. Waiting to invest, however, can be a wasted opportunity. Debt recycling lets you tackle both goals at once.
Online searches and forum posts reveal a lot of confusion about debt recycling, in many cases because it isn’t a single strategy. There are several variations on the central theme. Here’s an outline of the basics and the main flavours.
What debt recycling actually is
At its core, debt recycling is a financial strategy that replaces non-deductible home loan debt with deductible investment debt. It’s a way of paying off your home sooner and building an investment portfolio at the same time.
Typically, the process involves using home equity borrowings to invest in income-generating assets such as shares or managed funds. Income from those investments helps pay down the mortgage, while the capital value of the investments typically grows, accelerating overall wealth creation.
For a beginner-level walk-through of the mechanics, see our debt recycling guide. For why the strategy holds up across different interest-rate environments, see debt recycling — a strategy for every market. The variations below assume the basic mechanic is understood.
Plain vanilla debt recycling
The simplest version starts with paying down the mortgage using surplus cashflow, then borrowing the equivalent amount back to invest.
Imagine a couple with a $300,000 mortgage and $1,000 of monthly surplus cashflow, which they direct toward additional mortgage repayments. After 12 months, $12,000 is available for redraw.* In conjunction with their lender or an experienced mortgage broker, that available amount is split off into a separate loan account and borrowed back for investment purposes, say into ETFs or managed funds.
Total debt is still $300,000, but now it’s a mix of $288,000 non-deductible debt and $12,000 of tax-deductible investment debt. Investment income can be used to pay the home loan down further, and the strategy compounds each year. Over time the non-deductible debt drops toward zero while the investment debt rises toward $300,000. The shares, ETFs or managed funds should have grown in capital value as well.
This plain vanilla approach is fairly non-threatening. There’s no actual increase in debt levels relative to the starting position. The benefits of tax and market exposure are slow to begin with, but it’s the routine and compounding nature of the process that makes the strategy powerful over time, especially compared to a “pay off the home first, invest later” approach.
Care should be taken to ensure the loan structure keeps personal and investment debt separate at all times. Contamination destroys the deductibility and creates an ATO problem.
*In practice, interest savings on the loan will give them slightly more than $12,000 available.
Vanilla with a dash of spice
To kick off the strategy with more gusto, it’s common to apply for an increased loan facility and invest an initial amount on day one. The rule of thumb: a big enough amount to be meaningful, but not so much that it’s scary.
Compared to plain vanilla, there’s extra leverage at the start, and the potential for higher investment returns over time, assuming the portfolio outperforms the net cost of borrowing. This only works if the client has enough equity and loan-servicing capacity to support the additional borrowing. Otherwise the borrowing capacity needs to be created over time via extra repayments, the vanilla way.
The initial investment can be placed in a single transaction or fed in gradually to reduce market-timing risk.
The one-off debt recycle with existing assets
Existing investment assets represent another debt-recycling opportunity: employee share parcels, ETFs, managed funds acquired before the mortgage, from an inheritance, or from spare cashflow rather than borrowings.
Remember the aim: reduce non-deductible debt and replace it with tax-deductible debt. So if you have $100,000 of existing non-borrowed assets, that’s potentially $100,000 of debt you could recycle (less any Capital Gains Tax on the disposal).
A worked example. Say CGT comes to $10,000 on the sale. The benefit from a one-off recycle is then:
$90,000 × loan interest rate (say 6%) × marginal tax rate (say 47% including Medicare) = $2,539 of tax saved per annum, roughly a four-year break-even on the CGT cost.
Lower-CGT assets (e.g. employee shares immediately sold on vesting, investments with small gains) present an easy decision, as do assets you intended to dispose of anyway. Replacement assets bought with borrowed funds can be the same, similar or completely different investments according to preference. Just be careful with the ATO’s wash-sale provisions.
Debt recycling property
The same concept can apply to property assets, for instance a former principal place of residence or an investment property with significant equity.
These cases require detailed analysis. There are significant transaction costs to sell and buy, and investment properties usually incur material CGT. However, knocking $1 million off the home loan through the sale of another property and buying a replacement investment property (recycling $1 million of debt) can produce around $28,200 per annum in tax savings. Even more compelling if you wanted to exit that particular property or location anyway. Property advice from a buyer’s agent can also help you identify the right replacement asset.
Properties most likely to suit a property-based recycle include:
- Former principal residences (no CGT) that were largely paid off.
- Inherited properties that pre-date CGT, or were themselves a principal place of residence.
- Pre-relationship homes owned as a principal residence before a new partnership.
Property recycle with a trust
The last variation also involves property, but applies where a former principal place of residence is intended to be retained as an investment property, and where there’s a desire to maximise tax-deductible debt.
Under this strategy, the property is sold to a trust structure with full borrowings, releasing maximum equity for non-deductible debt reduction. Costs to weigh include stamp duty on the transfer, annual accounting costs for the trust, and usually land tax. Savings include sale costs on the property and stamp duty on a replacement property (assuming the alternative was the previous property-recycle strategy).
Using the same $1 million example: when the fully paid-off property is sold to a unit trust under this approach, the $1 million of debt made tax-deductible can generate up to $28,200 per annum in tax savings, net of trust running costs and land tax.
The takeaway
Many Australians have financial goals that include both a debt-free home and a decent nest-egg. Tackling them in parallel via debt recycling can make both happen faster than the sequential approach.
The variations all share a common theme: apply any available cash (from surplus cashflow, investment income, or disposal of existing assets) against non-deductible debt, then borrow funds back to invest, resulting in tax-deductible debt. The right variation depends on the assets you start with, the leverage you’re comfortable with, and the tax position you want to optimise.
The AGS Financial Group team includes financial planners, accountants and mortgage brokers experienced with all of these strategies. Get in touch for an initial discussion.
This article was written by Alex Berlee and was originally published in FirstLinks on 8 January 2025.