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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!!!
     
    qldfrog likes 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.
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