Debt recycling – how to make the most of your loan

Pay off your non-deductible debt – such as a home loan – as quickly as possible, while also increasing your wealth in the long term.

Known as debt recycling, the strategy involves recycling the debt in your family home with tax-deductible debt from your investments.

According to SmartMoney Wealth Management Co-Founder Peter Kaleski, the concept itself is not a well-known or popular one in Australia and often people are applying the strategy without realising they are using it.

“The reason for this is that many people will borrow money to buy investments and then direct any surplus income from these investments towards paying extra on their mortgage, not realising this is referred to as debt recycling,” he said, adding that it is only beneficial for certain investors, so people should educate themselves on the risks involved and the advantages before diving in.

“Debt recycling is typically reserved for those that have good cashflow, a long-term view on their overall strategy, and those that are comfortable with taking a higher level of risk when it comes to investing.

“The reason I say ‘higher level of risk’ is because the strategy involves borrowing money for the purpose of purchasing investments, which not only have the potential to go up in value and produce a strong income but could also go down in value and income.”

Mr Kaleski said one disadvantage was if the interest rate on a loan was not fixed – a rise in interest rates could lead to your repayments increasing.

“This can put pressure on your cashflow, which can be compounded further if the income from your investments is lower than expected,” he said.

Furthermore, assets bought with borrowed funds can sometimes fall in value.

“This means that even if you receive tax deductions from the investment over time, it can still fall in value and you can still be in debt even when you sell the asset,” Mr Kaleski said.

Finding out about the concept a few years ago from her accountant but not investigating it in much detail at the time, Ceridwen Foster eventually put the power of debt recycling into motion after meeting Mr Kaleski some years into her search for a financial advisor for herself and her partner.

“Once completing our risk profiles and understanding our risk tolerance, we were aware that we wanted to be a bit more assertive in our financial investment strategy to grow our financial asset base faster than we were at the time,” Ms Foster said.

“The statement of advice provided by Peter initially planned for us to look at debt recycling within three years.”

However, they were able to implement a debt recycling plan earlier than anticipated due to the pandemic and having implemented the investment advice received from Mr Kaleski, which enabled them to free up a considerable amount of cashflow.

From here, they were able to upgrade to a larger family home and use their apartment as an investment property.

Ms Foster said if you were looking to implement the strategy, to make sure to find an advisor who understood you, revealing she met with a number of professionals.

“Some tried to lock us into buying investment properties without running us through the numbers or explaining why it was a good investment for us,” she said.

“Most talked down at us, as though we would not understand the concepts, and suggested that we should just take their advice.

“Having an advisor that understands your goals and works with you as a partner is critical.”

Ms Foster said you should also do your own due diligence.

“Ultimately, you are responsible for your own financial wellbeing,” she said. “You can surround yourself with trusted advisors, but you are the one making the decisions.”