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Debt Recycling

Discussion in 'Medium/Long Term Investing' started by kid hustlr, Oct 6, 2019.

  1. kid hustlr

    kid hustlr

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    Debt Recycling is not something I've seen discussed much (if at all) on this forum so I thought I'd start a thread on it. If you have questions, please fire away!

    *None of the below is financial advice*

    What is debt recycling?
    Debt recycling is in effect using an investment loan to pay of the loan on your house. The reason for doing this is that investment debt is tax deductible, whilst the loan used to buy your home is not deductible.

    Example:
    Jack and Jill own a 1,000,000 home and have paid off 300k. The remaining loan is 700k. As Jack and Jill are good earners and we are in a low interest rate environment, Jack and Jill go the bank and ask for a second loan to the value of 100k. The loan is against their house, which subsequently allows them to borrow at mortgage interest rates (circa 4%) as opposed to margin loan rates. The loan is also interest only. This keeps their overall debt on the home at 800k (80% LVR) however they can now use that 100k to invest.

    Using the 100k in the second loan, they go and purchase 100k of Vanguard Australian Index Fund yielding 5% after franking.

    At the end of the year, Jack and Jill have earned 5k in dividends - they pay the 4k in interest for the loan and take the remaining 1k (before tax) and use it to pay off their home loan. Any capital appreciation on the equities is cream.

    This is a simple example, however this is in effect what debt recycling is and how it allows those of us who hold a mortgage to simultaneously gain equities (or other investment) exposure.

    Key points:
    - By having both loans against your house you do place your house at risk. Everyone has different risk tolerance and I personally would never place myself in a position even close to putting my house at risk. Do your numbers
    - Leverage worth both ways and by borrowing to invest you to exposure yourself to added risk
    - There is no 'free lunch' you need to have equity in your home (either through saving well or capital growth of the home) to be able to undertake this
    - Taxation is important, all investment loans and subsequent transactions should be kept completely separate from your standard home loan and transactions. Any mixing of transactions between accounts will muck up the tax benefits
    - The more complex the investment strategy, the more complex the taxation management becomes. For example if you were borrowing to invest in trading, the accounting and tax treatment to my understanding requires closer scrutiny and you are best seeking advice. a simple buy and hold strategy is probably best for debt recycling

    I personally am undertaking this approach - I will slowly drip money into the market as my family pay off our loan whilst also keeping an investment amount available for any possible 'rainy day' share market scenarios where access to capital will be handy.

    If you have any questions about any of the above - fire away!!!
     
    tinhat, barney, MovingAverage and 2 others like this.
  2. qldfrog

    qldfrog

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    Interesting, i will add a small (per number of people affected, not by the amounts involved) interesting case
    Your ppor is cgt free and its interests are not deductibles but this is only for the first 5 acres /2 ha
    Any acreage property above 5 acres will then be made up in the ato eyes of a 5acres ppor plus a land subject to std business rules
    So your home loan on your 5 acres plus acreage will from the start be made of a deductible part
    Same for rates etc
    I wish i had known that much earlier in my ownership of my current home
     
    kid hustlr likes this.
  3. Trav.

    Trav.

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  4. Austwide

    Austwide

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    I don't think there is a time limit to do amended tax returns, also if you haven't claimed the interest and rates etc they can be subtracted from the cap gain
     
  5. Austwide

    Austwide

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    Some time ago GEM home loans structured a loan where you could have a PPOR and an investment house under the one loan. Each part of the loan had separate interest portions and options.
    You could opt not to pay any repayments on the Investment side and let that interest accumulate and pay more on the non-deductible home loan as long as the interest due on the total debt was covered.
    Hence the home loan component fell quickly while the investment loan grew.
    The ATO had a court case against them based on loan purpose but GEM won the case.
    The ATO were going to appeal the decision.
    About then I left the broking business and never found out what happened but if still available is a very effective loan for investors
     
    qldfrog and Zaxon like this.
  6. qldfrog

    qldfrog

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    Thanks, but yes I will claim the proportion of rates etc
     
  7. costanza

    costanza

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    I think you need to be a little careful thinking you can claim the cost


    Yes I agree this can be a very effective strategy in accelerating paying down non-deductible mortgage debt, whilst building up a portfolio of income producing assets, be they shares or property. The key points are you either need to be well ahead in your mortgage or have the excess income to regularly pay above your minimum monthly mortgage.

    If you are comfortable with adding even more risk a margin loan can be taken out with the excess equity. Using Kid Hustlrs example the $100K can buy $100K worth of ETFs using a margin loan to, the cheapest of which can be prepaid for 12 months at 4.5%. To further enhance cashflow this can be capitalised to the margin loan. The $10K in dividends should be paid straight into the non deductible mortgage, resulting in a more rapid pay-down of this component of the loan.

    People need to be aware of the extra risk taken on, ie massive market corrections, margin calls etc, so it would not be advisable to go "all in" with this strategy. Keep some equity on the sidelines.
     
    kid hustlr likes this.
  8. qldfrog

    qldfrog

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    This is only for the part above the 5 acres and the ppor , where I will pay full capital gain on sale of the property
     
  9. MovingAverage

    MovingAverage Smoke me a kipper

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    I have been doing this for several years except I took the investment loan as a line of credit against my investment property and not PPOR. I use the line of credit to purchase equities and any profit from those equities is directed to reducing my non-deductible loans. It's a good strategy and something I am far more comfortable with than margin loans.
     
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