Debt Recycyling

For many of us, owning a home is only possible with the financial challenge of repaying a large mortgage. The focus is on cash flow and reducing the loan as quickly as possible. Wealth creation plans are left until ‘later in life’ this leaves little time to benefit from the compounding nature of investing. There are ways to ‘turbo charge’ your mortgage repayments with the right advice and wealth creation strategy in place.

This ‘turbo charging’ strategy is often also called ‘debt optimisation’ and it works by reducing non-tax-deductible ‘bad’ debt (your home, car and personal loans) and replacing it with tax-deductible ‘good’ debt (investment loans) that are used to invest in growth assets (property or shares).

A Case Study

Brad and Angela have a $400,000 mortgage against the family home. They wish to retire in around 20 years and in order to pay off their home loan within this time frame. They are currently paying $37,000 a year (approximately $27,000 in interest and $10,000 off the principal). Following a review of their finances and mortgage interest rates they have around $20,000 of surplus income each year. Good cash flow coaching and planning comes into play here.

As with all advice they have a number of options but that is where a good relationship with your financial adviser comes into play.

  1. Adding their surplus income to their existing home loan repayments to repay it as quickly as possible then once repaid they would start investing. (This means they only have the capital growth of their home working for them).
  2. Invest their surplus income of $20,000 while continuing to make their current home repayments over 20 years. (This starts a wealth creation plan and investment mindset).

So what does this mean? Similar to the first strategy they should use their surplus income to pay off as much of their home loan as possible. The strategy then requires Brad and Angela to re-borrow the equity in their home created by their home loan repayments and invest it into growth investments (again this could be property, shares or managed funds depending on your needs and comfort level).

After the first year they manage to pay $57,000 ($37,000 current repayment + $20,000 surplus income) off their home loan – $27,000 in interest and $30,000 off the principal. Using a separate investment line of credit they redraw the principal amount that they have paid off their home loan and invest.

A Year On…

By adopting this strategy Brad and Angela’s total amount of debt has remained the same, however a portion of it ($30,000) is now tax-deductible ‘good debt’ – as this borrowing has been invested into an income-producing asset. Brad and Angela are now entitled to claim the interest costs on this $30,000 borrowing as a tax deduction. As their investments also provide them with an additional source of income as well as franking credits, their strategy will become even more tax-effective.

The additional source of income allows them to increase the rate at which they reduce their home loan (‘bad’ debt) which in turn allows them to increase the size of their investment loan (‘good’ debt) and investment portfolio over time.

As with all wealth creation strategies it is important to get your numbers done and explore if this is an appropriate strategy for you and have someone to coach and guide you along the process and keep you accountable.

If you would like to review your wealth creation strategies contact Money Mechanics today.

Scott Malcolm (scott@money-mechanics.com.au) is Director of Money Mechanics (ph: 6257 5557) a fee for service advice firm who are authorised to provide financial advice through PATRON Financial Advice AFSL 307379.

 

The information provided on this article is of a general nature only. It has been prepared without taking into account your objectives, financial situation or needs.  Before acting on this information you should consider its appropriateness having regard to your own objectives, financial situation and needs.