Tax Tip 2: What is Debt Recycling?

‘Retirement’ can arrive sooner if you can pay off non-deductible debt faster.

Interest on a loan used to purchase the main residence is not deductible – some call this ‘bad debt’. While interest on loans used to purchase investment properties (shares, business etc. too) is deductible – so called ‘good debt’.

So wouldn’t it be good if you could change bad debt into good debt so you increase deductions to save tax and pay off loans faster?

Well, you can!!

As an example, most people would be paying PI on their home loan. The balance would be slowly decreasing. Some would be paying extra on the loan to pay it down faster. If you could reborrow this extra money paying off the loan and then invest it you would be charged around 4% pa in interest. This interest would then be deductible against the income from the investment. If the investment earns more than 4% pa then you would be in front and the extra money received could then be used to pay down the bad debt even faster.

Further reduction of bad debt would potentially mean more funds are available to be borrowed to invest. This in turn would potentially lead to more income to pay off the bad debt which could then be turned into good debt by borrowing again to invest.

If all goes well this could enable the bad debt to be paid off much quicker as the compounding takes effect.

This could be done with property, but most property would end up negative cash flow. But it could also be done with negative cash flow property and just hanging on for a few years and then selling and using the proceeds to pay down the bad debt and then reborrowing.

You could speak to a licenced financial planner about using shares to do this. Shares are much easier to buy and sell and the costs in and out are very low.

Carefully planned, debt recycling can get you where you want to go sooner.

2018 update – these days owner occupier loans are at a cheaper interest rate than investment loans. Properly structured, debt recycling can allow owner occupied interest rates for investment loans, helping you to recycle a little bit faster still.

One thought on “Tax Tip 2: What is Debt Recycling?

  1. Hi Terry,

    Hoping you can assist! I’ll really like to accelerate paying my PPOR loan ( $660K)

    I have 1x PPOR (660K) & 1x investment property ( balance of 380K in IO loan, approx 98% LVR) & about to cash out some equity ($330K) against the PPOR (77% LVR) into a new IO Loan & Offset for investment purposes (another Property & maybe start a share portfolio).

    My PPOR loan is $660K (which is front of mind & a concern) with full offset account which my Work Salary income, & rental from the 1x IP goes into.
    Now the expenses of the IP also get paid from my main PPOR Offset, ( monthly loan expenses, rates, water, maintenence). & so here inlies my query re: oprtimising the loans structure..

    Now that i have a decent amount of “investment funds” ($330K) in a seperate loan, to optimise my structure should i keep the Rental income paid into my non-deductable PPOR offset but change the monthly loan repaymants for the IP to come out of my new Investment only loan?
    Will that interest amount will tax deducatable?
    Now I understand that a “deposit” for an IP is tax deducatable ( im looking into a $500K for IP#2 which i’ll use 100K-$120K out of this $330K ) but just not if monthly repayments for Serving IP#1 & eventually IP2# for that matter also get taken out of the same “pool’ would spoil it. (will it lead to Capitalizing interest and ATO get upset? )

    OR – would i better idea be split the $330K into a smaller “IP Servicing loan”. eg ( $270K & a seperate $60K IP loan to service monthly repayments & expenses for the next few years). im paying roughly 20K a year in interest & roughly getting 20K per year in rent. Without depreciation, the $5K expenses are making me go a little backwards

    (BTW. Covid really messed up IP#1 . 1x bed apartment in St Kilda, Mel. Worth $10K less atm than when i bought 5x years ago but rent is catching up. Should hopefully get back to neutral cashflow next year)

    Ive followed & enjoyed your posts on Property chat over the years but now than im in a position to utilize these strategies i cant seem to find the relevant links/posts. im sure you have spoken many times about the optimum scenario using offsets & split loans. Any links you could shoot through email would be great! Happy to use your mortage services to fund the IP if you can help answer my predicament


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