Debt has long been a pressing issue for many Australians and has only become more apparent in recent years. With the high cost of living and sluggish wage growth, many people struggle to manage their finances and get ahead financially. As a result, more Australians are looking for alternative ways to get debt-free, such as debt recycling.
In this blog, we’ll explore the concept of debt recycling and examine its benefits and risks to help you determine if it is the right strategy for you.
What is debt recycling?
Debt recycling is a financial strategy that involves using the equity in your home to invest in income-producing assets, such as shares or property, while simultaneously paying off your home loan.
The idea is that you borrow against the equity in your home, invest the funds in assets that generate income, and then use the income to help pay down your home loan.
How does debt recycling work?
Here’s a better look at how it works:
- You take out a new loan, known as a line of credit or equity loan, against the equity in your home.
- You use the funds from the new loan to invest in income-producing assets.
- You use the income the investments generate to pay down your home loan.
- You repeat the process, using the equity in your home to borrow more funds and invest in more income-producing assets.
The benefits of debt recycling
While debt recycling is an unorthodox method of paying down your home loan, it can deliver several benefits to Australian property owners. These include:
- Tax benefits — If you invest in income-producing assets, such as shares or property, you may be eligible for tax deductions on the interest paid on your investment loan.
- Wealth creation — Over time, the income generated by your investments may help you build wealth and achieve your financial goals.
- Accelerated mortgage payments — By using the income generated by your investments to pay down your mortgage, you may be able to pay off your home loan faster than you otherwise would have without a debt recycling strategy.
The risks of debt recycling
Like any other financial strategy, debt recycling also brings a degree of risk that you must consider before deciding if it’s the right strategy for your financial circumstance. These risks include:
- No profit guarantee — Any investment carries the risk of limited profitability. You may use a debt recycling calculator to determine the return rate you need to achieve for you to start generating income, but still, there is no 100 percent guarantee your investments will generate the returns you’re hoping for.
- Potential rate rises — Interest rates tend to fluctuate regularly, impacting your investment returns and ability to repay your loans. However, opting for a fixed interest rate can prevent your repayments from increasing.
- Higher debt levels — Borrowing against the equity in your home carries the risk of increasing your debt levels, which can put you in a precarious financial position if you can’t repay your loans.
Want to see if debt recycling is the right strategy for you?
Debt recycling can be a powerful strategy for building wealth over the long term, but it’s not without risks. If you’re unsure whether debt recycling is right for you, it would be wise to seek the advice of a financial advisor who can help you make an informed decision.
At Financial Spectrum, we believe in empowering our clients through financial education. We can help you better understand your financial position before crafting a tailored financial plan to help you achieve your goals.