Last updated: November 2023. Original post: 2018.
Debt recycling gets talked about as a tax effective strategy. But it’s rarely broken down in plain English how it works in practice.
In this article, I’ll explain how debt recycling works, when it’s a good idea and some things I see missing from the conversation.
Hopefully, by the end of it, you’ll have a good idea whether debt recycling feels right for you. There’s a lot to discuss, so let’s get started!
Debt recycling is a strategy which aims to turn your current non-deductible home loan into a tax-deductible investment loan.
This involves paying down your mortgage and re-borrowing that money to invest with – hence the ‘recycling’.
In this way, you end up with a higher return on your investment. That’s because you are taxed less as you now have a tax deduction you wouldn’t have before.
But as I’ll explain, it’s different from using leverage and increasing your debt to invest.
Debt recycling can be very effective, but there’s a few things to understand first and it’s crucial this strategy is implemented properly.
Generally, you take money you were going to invest and pay down your home loan instead. You then pull that money back out and invest it. In doing so, you make that portion of the loan tax deductible.
As you keep paying extra off your home loan, you continue to redraw that money to invest into income producing assets like shares.
You can use the investment income, regular savings and tax savings to pay down your non-deductible home loan even faster to speed up this process.
Here’s one example of how it looks using a line of credit…
(Courtesy of Peter Thornhill)
When you recycle debt, the non-deductible mortgage gets smaller, while the investment loan generally gets bigger. Eventually you’re left with just a tax-deductible investment loan.
At this point, you can choose whether to also pay off the investment loan or not.
Sometimes debt recycling is spoken about like a magical way to pay off your home loan, save tax and build wealth at the same time. While that can be true, it’s not for everyone.
First, it’s a bit more complex than simply investing and paying down your loan as normal. Second, you need to already be relatively good at managing money and your accounts.
Smart money management, saving and investing remain the key ingredients for building wealth. Debt recycling can be seen as tinkering around the edges.
Having said that, it is pretty cool! It can let you get the best of both worlds, save tax, and increase your returns. Let me explain how it works.
If you’ve decided you want to invest rather than get rid of your debt, here’s why you might consider this.
Debt recycling is more tax efficient than simply investing the same amount of money. You are saving the tax you would have paid on the income from your investment, without cycling it through a loan first.
Here’s an example…
1. You have a home worth $500k with a $300k loan. You also have $100k in your offset account.
2. You can split your home loan into two, so that you have $200k loan and $100k loan.
3. You pay off the $100k loan with your offset money. Then you pull it back out, sending it straight to your brokerage account (if buying shares).
4. Interest on the $100k loan is now tax deductible, provided you invest in an income-producing asset.
Tip: you may wish to pay down your loan balance to $1 rather than zero in case it gets closed. Best to check with your lender to see if they will leave the loan facility open with a zero balance.
Okay, here’s how it works using nice round numbers for simplicity using the steps above. You have a $300k home loan with a 4% interest rate, and $100k in cash.
Option A: Investing without debt recycling:
Invest $100k. Receive $4k of income. If tax takes 50%, you’re left with $2k income.
Option B: Investing with debt recycling:
Pay down $100k of debt (your non-deductible home loan). Redraw $100k and invest it. Receive $4k of income.
This time you can claim $4k of interest as a tax deduction (interest on $100k). You now pay tax on $0k of investment income, which is… nothing.
Okay, let’s recap…
With both options you have $300k of debt. You’ve paid the same amount of interest, and you have invested $100k.
But by debt recycling, you’ve saved $2,000 in tax that year compared to if you didn’t. And if interest rates are higher, the tax savings increase.
By the way, I created a spreadsheet to keep an up-to-date estimate of my annual dividends to help me plan my finances. If you’d like a copy for yourself, simply enter your email below and I’ll send it to you.
Even if you invest in the exact same fund or asset, debt recycling can actually improve the returns you earn from that investment.
It sounds odd, but let me show you.
In the above example, by debt recycling $100k, our investor ended up $2,000 better off at the end of the year. That’s an extra 2% per annum on those numbers (because the tax savings will continue next year).
Now, there aren’t many ways to juice your returns without taking more risk, but debt recycling ranks pretty damn high on the ideas list.
You can always get a tax expert to run through the numbers for your particular scenario. And a good mortgage broker can help you set up the loans correctly to make it easier. But I hope this explains the potential benefits.
As interest rates have risen, so have the tax benefits of debt recycling. In general, a higher interest rate means there are more tax savings to be had. And if your tax rate is higher than what I’ve quoted, it’s even more.
So if you were on the fence about it before, it might be worth a closer look. It’s also one way of dealing with the annoyance of higher mortgage rates!
Some people get this one wrong.
To do debt recycling correctly, you must invest in an asset which pays you some sort of income.
You cannot claim interest against an asset that generates no cashflow. Otherwise you’re essentially trying to claim a tax write-off against no income, which makes no sense at all.
But don’t take my word for it. Here’s the official ATO statement regarding tax deductions on debt for investing:
“If you borrow money to buy shares or related investments from which you earn dividends or other assessable income, you can claim a deduction for the interest you pay.”
“Only interest expenses incurred for an income-producing purpose are deductible.”
You have more cash each year after tax than if you simply invested and paid down your mortgage normally.
You can use this extra money to pay down your non-deductible mortgage further or increase your investments. In this way, debt recycling can actually help you pay down your home loan faster.
As time goes on, the tax savings increase as more of your home loan gets turned into investment debt.
Now, another thing people confuse is the idea of debt recycling, with the strategy of taking on more debt to invest and grow the portfolio faster.
Debt recycling is using debt to invest with, but you are not increasing your debt. You are ‘recycling’ your current debt into a new purpose.
To be clear, if your loans are interest-only, your debt remains the same. If you’re paying P&I, your loan balance will continue to reduce over time.
Now, there’s two main ways to implement this strategy. The first one we’ll call debt recycling in chunks.
This is probably the most common method and what we’ve described so far.
You save up a lump of money, pay down a chunk of your mortgage, and then re-borrow and invest those funds.
Then it’s a case of saving up another lump of cash and repeating the process.
The reason you might do it in chunks is because you’ve already saved up a good pile of cash, perhaps in your offset account, and that’s why you’re now looking into debt recycling.
But there’s another reason. Banks often have a minimum size loan split they will create, such as $20,000 for example.
There’s also a way to do debt recycling while investing in shares on a monthly basis.
With this method, you use some equity in your home to create a separate loan split. You pull this equity out and put it into a new offset account which you attach to your new loan split.
As you save each month, instead of investing, you pay down your main home loan. You then pull the same amount out of your new offset account attached to your new loan and send this straight to your brokerage account to buy shares.
The interest on the new loan is tax deductible because you’ve used that money for investing. This lets you dollar cost average into shares rather than investing big lumps, which is more enjoyable and less stressful.
If you don’t have enough equity in your home for this, you could also set up a loan split now for say $20k with your current loan. Pay it down with your savings each month.
Once it’s paid down, each month you can take out the amount you want to invest, while you create another split to start paying down with your regular savings to repeat the process.
This has been a common question. There’s no special loan for debt recycling.
It can be a normal plain vanilla home loan. But you do need the ability to create splits and redraw, which many have. An offset account may be helpful too for the above approach.
Many home loans can be split into smaller portions. Just check with your bank whether it can be done. Think of how common it is to split a loan between fixed and variable rates – it’s basically the same setup.
You don’t need to end up with 10 small split loans either. You can request to have your main home loan limit decreased, and your investment loan increased. This makes things more organised, but it does depend on how flexible the lender is!
Yes, it is definitely legal. Some people think the ATO will come after them if they’re utilising this strategy. But that certainly doesn’t seem to be the case.
The ATO have fielded questions on debt recycling on their community forum – here – and have not suggested they have an issue with this approach.
Yes, this is a tax-efficient way to invest. But it’s hardly some type of elaborate tax avoidance scheme.
Remember, you are earning higher net returns than you would otherwise by structuring it efficiently. And you’re actually going to end up paying more tax overall by investing than if you simply paid down your home loan.
You aren’t stacking up a bunch of bogus tax deductions for the sake of it (interstate travel to ‘manage’ investment properties?).
The smartest goal is to actually build a portfolio so large you end up paying lots and lots of tax – that’s a fantastic ‘problem’ to have.
Anyway, if you’re still concerned you can always reach out to the ATO with details of what you plan to do and see what they say. Try their community page linked above.
You can debt recycle using both types of loans. When setting this up, your main home loan is probably a principal-and-interest loan.
For debt recycling, it’s more effective to use interest-only loans. This means your repayments will be lower and you can then divert more cash towards paying down your non-deductible mortgage even faster.
Having said that, these days switching part of your loan to interest-only will probably require an assessment of your borrowing capacity once again.
You could also use a Line of Credit home loan too, but interest rates are even less attractive again, so I probably wouldn’t bother with that.
So, many times, it’s just easier and cheaper to go with a typical P&I loan.
After going through this process, many people wonder about the end game: once my loan is fully tax deductible, should I pay it off or keep it and continue building wealth?
This decision, like many others, is a personal choice. As always, there are pros and cons to both paying off your mortgage and investing, which I’ve covered here.
When that loan is tax deductible, however, this loan is a lot more attractive to keep around, since it reduces the taxes on your investment income. That said, many folks will still prefer to end up with zero debt and a fully paid off home.
If the goal is maximum wealth with no plans for retirement, keeping the loan open and investing further might be the most appealing option. But if one is looking at semi-retirement or leaving work altogether, then removing the debt and having lower expenses would be beneficial for their cashflow.
The loan could be paid off over time, or all at once, by selling shares. Now, it could be a bit counterproductive to sell shares, pay CGT, and then pay down the loan.
That doesn’t mean it’s the wrong choice, but it is something to be aware of and factor in. In all likelihood, most scenarios would still see the investor come out well ahead of not debt recycling at all.
As mentioned, you may want to get a new offset account to attach to your loan split. This helps you avoid any sort of contamination between your personal funds and money for investment.
If you can transfer loan proceeds from the loan account straight to your brokerage account, there’s no real need for the offset. But some loans don’t have that functionality and you can only move the funds into a transaction account first before sending it elsewhere.
Moving loan proceeds into your everyday account and then to your brokerage account to invest would then contaminate those funds. Keep the loan split and the offset funds completely separate from your main loan and offset account. Don’t mix the money!
It also helps if you have a lender which doesn’t make things difficult. And from what I’ve heard, not all lenders are the same when it comes to flexibility with your loans.
As you can tell, there’s a lot of ins and outs to debt recycling. If any of this is unclear (or even if it is) then it might be best to see a trusted tax expert to ensure you’re implementing this strategy the right way.
It’s probably also a good idea to get help setting up your loans correctly, so perhaps see a mortgage broker who knows what they’re doing (recommendation below).
Debt recycling is not for everyone. Most people like to keep things simple, with their home and investment activities completely separate. And if you just want to get rid of your mortgage ASAP then just focus on that.
But for those who don’t mind taking on some extra work and complexity, debt recycling can definitely be a profitable and tax effective strategy, helping you pay down your mortgage faster while building investments at the same time.
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Thanks for the in depth article!
Although you mentioned lending has tightened up, I think it needs to be emphasised that unless you have a LOC or a global limit facility (e.g. AMP Master Limit) you are at the mercy of lender/government policy to be able to access equity in the future. For that reason, if you are serious about a debt recycling strategy then I suggest going for one of these products rather than a standard P&I/IO loan then refinancing frequently.
Hi Anthony,
How is the interest rate of this global limit facility compares to standard P&I / IO loan?
Also, can we contact AMP directly to avail of this product and set this up on our own or do we need a mortgage broker to do this? We have spoken to a mortgage broker but seems there are fees involved.
We are like 8 months from buying our first home and one of the reason we decided to buy is because of this debt recycling. If we can set this up on our own then we would prefer that.
Cheers,
Tarly
Hi Tarly,
You should be able to apply directly to AMP however I suggest speaking to a mortgage broker who will be able to compare to a number of products including regular P&I/IO loans to see if there is a benefit. Just make sure it’s someone who has experience in this area.
Most mortgage brokers don’t charge a fee and get paid a commission from the lender (a cost of distribution for the bank).
Thanks Anthony.
Yep good point, there’s no guarantees of being able to access that equity upon appication. That makes using a Line of Credit more attractive and worth paying extra for in many cases. There’s also a rare chance that LOC loans are clamped down on – I mean it’s still just a loan at the end of the day, rates can be increased if the bank wants to encourage you to switch. But I agree with your point that LOC is a more optimal structure for doing this type of thing.
Dave,
I did learn something new and it definitely is an excellent strategy.
The main risk to it being, as you pointed out, if you overextend yourself by borrowing too much in an environment where your dividend portfolio gets crushed and the RBA keeps increase the interest rate in an inflationary environment.
However, it actually appears to be the best thing to do at the end of a big fat financial crisis with interest rates and markets at record lows.
At this stage, with the US longest bull market in history, i would rather keep a larger than normal cash pool in a high rate savings account or offset account to have enough ammunition to “pounce” when the market turns.
Cheers David.
Definitely not without risk, but can work well for some people and certainly gets a lot of discussion with different views on it.
Makes more sense when market and rates low but unfortunately that’s likely to be the scariest possible time to invest! Not many people would have the stomach for it. Your approach of extra cash on the side is a sensible and lower stress way to approach it 🙂
I’ve put this strategy in the ‘too hard’ basket for now. It has always interested me though and I may consider it in future. Thanks for the detailed article to refer back to.
Completely agree. Simplicity adds to the attractiveness of pursuing FIRE. Strategies like this seem to add to the “more money, more worries” basket which I tend to try to avoid. It’s nice to know there are other paths that lead to Rome, but I’m happy with the straightforward one (which is still, by far, the path less travelled).
Thanks Miss B. I don’t blame you for that – it’s not for everyone. Keeping it simple is usually the best course of action!
A good writeup on a topic I’d heard a lot about but never really seen explained in detail before, thanks very much! I can’t say it’s one I’m keen on for myself for a bunch of reasons but it can certainly make sense for a lot of other people.
One quibble, although Labor are planning on axing the refund on franking credits it’s only for the cash refund if you have more franking credits than you have tax payable. So if you’re still working and earning a reasonable amount chances are pretty good you’ll still be able to use all of the franking credits because you’d be paying a fair amount of tax on the income from your job and you can use the franking credits there. After you stop working is likely a different matter though.
Thanks mate, glad you liked it.
It’s definitely not for everyone – I’d even say it’s not suitable for that many people at all.
Yes as you say the case isn’t as bad if you’re still working. And clearly many people will be relatively unaffected by franking changes (debt recycling or not) since they’ll still be working. But given financial independence is the focus here, in the retirement scenario I painted it will make a big difference to cashflow and can really mess up someone who’s almost FI and using dividends to retire while keeping the debt around as part of their portfolio, even more so if interest rates are going up.
Something to consider before people get too excited about debt recycling 🙂
My issue is that to get paid a high enough dividend to be worth it you would need 500k+ in lics
Stuff this! Keep it simple and just pay off the loan quickly! We are paying our homeloan off over 5 years and then using spare cashflow to invest over next 7 years. Way to much risk for reward for our family. I’m in West Aust, I have seen layoffs of workers and house prices drop 20% over recent years.
Hahaha I love it! Can’t disagree with your approach Mr FMT, sounds very solid 🙂
Hi Dave,
Another interesting article. I recently refinanced my IO home loan as it was due to got to P&I and I was thinking of making use of debt recycling. I ended up with an ANZ P&I loan for $150K and a LOC for $200K otherwise the bank wasn’t interested in doing business! Interest rate has recently increased to 3.95% which I can afford. I am about to receive an inheritance. I can easily pay off the $150K loan from the inheritance but instead I have been considering as an alternative of buying an equivalent amount of ANZ Bank shares which currently pay a dividend I believe of 6.2% + 100% franking. Intention is to set up dividends as 50% DRP and 50% off home loan so loan wont be tax deductible. On this limited information does this sound viable?
Well it’s viable, but I wouldn’t do it. That’s way too much to have in one single company. Sure it’s a government guaranteed bank, but we will have a recession at some stage and ANZ may really struggle and the dividend could be cut severely. I’d feel a lot more comfortable investing it into a diversified share fund like an LIC or an index fund. Dividends will still be reasonable and a lot more reliable, with far less risk.
One option is to pay off the $150k down to zero (or maybe $1 so the bank doesn’t close the loan account) and then withdraw the money straight to a brokerage account to be used for shares. Then buy $150k of diversified shares and the loan will then be tax deductible. But you could just as easily pay off the $150k, and just keep the LOC for investing – keeps overall debt lower, home loan gone and lower stress, lower risk position. I can’t advise of course these are just ideas and things I would consider.
Hi Dave,
I’ve been considering a similar approach to what you have mentioned in your second paragraph above. Do you know if this approach is above board according to the ATO? I’m planning on discussing it with my accountant in the near future.
Thanks,
Rob
Hi Rob – there is nothing suss about this plan. All you are doing is paying down your mortgage, but also re-borrowing this money to invest in other assets (in this case shares). This can be done by paying off your mortgage entirely, or in big chunks, or in increments like described. As long as you are clearly separating what portion of debt is for investment and what is still your personal home loan, then there is no issue. You are claiming the interest costs on the debt that is being used for investing – which is why it must be kept separate from your existing home loan. As long as you are getting income from your investments, this interest is tax deductible.
I’m reading this whilst getting nasty flashbacks to a particularly complicated series of negotiations I had with the ATO a few years back, and I feel compelled to give a serious caution to future readers:
Please read up on Part IVA of the Income Tax Act. I’ll do a bad job of summarising it here:
-If the ATO can demonstrate, via an objective test detailed in the Act, that you made your debt recycling setup for the purpose of minimising your tax (which you obviously did), the tax benefit is null and void and you will be paying back all you have previously claimed (plus a potential penalty).
You need to have an OBJECTIVELY provable reason for setting up your accounts/funds transfers the way you have, that isn’t to generate a tax advantage. It isn’t good enough to say you set it up this way because you really like the idea of paying off your home, for example. This would fail the objective test. There are situations that would qualify for this, but you need to be very careful. Read this part of the Act and make sure you can satisfy the eight matters required therein, objectively, before you proceed.
I don’t like this part of tax law – you should be able to use your own money however you want, including to pay off any debt you wish. But it is law, and the ATO is very aware of how far-reaching it is and keen to apply it.
Please be careful.
Thanks for this warning Whisk. It’s frustrating that some of the areas aren’t super clear on what is/isn’t allowed. My understanding is there are definitely valid ways to do it where the purpose is not avoiding tax.
In many cases, investing as described above would actually result in MORE tax payable versus just paying down your home loan, because dividends earned are higher than interest payable… so I’m not sure how they can argue you’re avoiding tax in that case. It’s just that this way you get to pay down your loan and invest for higher returns at the same time. You’re investing for the purpose of higher returns than your mortgage payments, regardless of the tax outcome.
Paying down a home loan and then deciding to borrow that money back out for investment is pretty common, so they’d be pretty busy if it was ruled that it’s not allowed. Maybe they would consider it a scheme of some sort, but that confuses me a bit.
Something to think about is that you might get a high dividend pay out but your total return can still go backwards if the price of the shares keeps dropping (ie your capital gains go negative).
Thanks Dave, how about those who have fully paid their mortgage? Is it worth getting an investment loan to build a share portfolio and then to reinvest dividends or use them to pay off the investment loan?
Depends entirely if the person wants to stay debt free or they don’t mind taking more risk for a slightly higher (possible) return.
As mentioned in the article, if rates go up the dividends may be less than the interest cost, so you could be having to help pay for the loan out of your own pocket – depending on your situation this may be fine or terrible. And you’d effectively be paying the loan off all over again.
I’d lean more towards making debt a permanent part of the portfolio, or remain debt free. But that’s just me, I tend to be an all or nothing kinda guy. Hope that’s helpful John 🙂
Quality of Blog posts getting exponentially better so rapidly. It’s obvious that lots of hard work is being put in. Well done Dave.
Unlike PT I like to reserve the use of leverage for when risk is low and margin of safety high. That is for in times of gloom. It all sounds good but we’re talkin higher risk strategies here so save your “limited” dry powder in the form of leverage for when it can deliver the biggest bang for buck for the least amount of risk!
Thanks Nodrog!
Very hard work, I’m flat out over here at Strong Money HQ 😉
Can’t argue with you there mate – there’s certainly a great opportunity to use it during scary times in the market. Everyone needs to stick with what they’re comfortable with, and you’ve found the right setup for you, which is key. I haven’t decided whether leverage will remain a permanent thing for us, or used selectively. Either way, we still have large debt and will do for quite a while yet, until we part way with the rest of the dead weight (as PT might say) he he.
I can see the benefits and cognitively agree. PT sure devotes a goodly chapter in his book about it too.
However, after scraping myself out of horrendous consumer debt and reinventing my finances over 5 years ago, I just emotionally cannot bring myself to go back into debt – I’m scarred by debt it seems!
Debt – It’s still very much the hot potato in our family.
But hey, another marvelous read and I’m pretty sure this is the only in-depth treatise on the subject there is to be fond on the ‘interwebs’ – well done.
Cheers Phil. Thanks for sharing. It’s definitely an emotive topic and there’s certainly no right answer for everyone.
I think people should probably stick with how they already feel about debt, because if they try it and second guess themselves later on at the worst possible time, it could do a lot of damage 🙂
It’s not a massive game changer anyway I don’t think. The main factors are of course saving, investing, and more saving!
Thanks for this article. I’ve heard this term a lot lately but could not get my head around how it worked. Now I have a better understanding. Well explained. Thanks.
Awesome, thanks Glenn, glad it helped!
Good article. I’m a great fan of debt recycling. Started 18 months ago against my PPOR debt. I do not use LOC or margin loans. I save up cash in offset linked to PPOR loan, split the loan once savings reach $10K/$15K, pay off, borrow and invest in LICs. Though I’m no expert in this area, doing so offers me few benefits like
1.) Less interest paid on non-deductible loan
2.) Diversification of asset classes (Property, Shares)
3.) Less tax to be paid in the form of franking credits refund even after dividends null out the interest paid. (This still works in the event Labour is successful in axing cash refunds of franking credits)
Say, I straight away use saved cash to invest in LICs, then I pay more tax on the dividend income and also would be paying more interest towards PPOR loan even though the diversification of asset classes still exists.
I understand your point of view with this strategy during the semi-retirement or retirement phase in terms of it’s benefits. But, for someone who is in accumulation phase and have decent salary income, it does have it’s place. I do not see any cash flow issues with this approach too as the amount I would have paid towards my PPOR loan without this structure is going towards split loan payments.
–
Thanks for sharing your approach Jaik 🙂
It definitely has its benefits and as mentioned I’d probably do it myself if I was in that situation. And it’s pretty clear there’s a wide variety of opinions on this topic so it’s great hearing everyone’s take on it.
Thanks for sharing your method Jaik2012.
Just wondering if what you are doing is equivalent to what Dave referred in part “Debt Recycling with Principal & Interest loans” ?
Great in-depth and well thought out article Dave. Just wanted to complement your commitment to sharing great content that adds value to your readers. Well done!
I tend to think debt recycling would be worth the extra risk, if you were in a position to refinance your home, set-up a LOC and invest during a market crash, so you can buy shares at a bargain price and then get higher returns due to the compounding effect. If there is an opportunity to take advantage of a bear market, then it could be worthwhile to accelerate one’s wealth and speed up their early retirement goals.
Thanks a lot Fergy, that’s much appreciated!
Yes it can definitely be used opportunistically with great results. You’d have to have strong conviction in what you’re doing though. Just imagine how scary a time that would be, when the market has crashed nobody else wants to invest, we could be in a recession and things will feel like they’re only getting worse – haha!
We’ll have to wait and see what the market throws at us and see how we really handle a situation like that. Perversely, I’m looking forward to living through it and writing about it 🙂
The problem with the second paragraph is that by the time the application gets approved, the market would be off it’s lows. Have to have this set up first and wait for opportunities. Also, we can’t really time the market. So just have to make sure you can afford the repayments regardless of how your situation changes.
Another great one Dave!
This is something that I have been thinking about heaps as I have the facility in place but trying to work out whether to use it at the moment.
It is a very interesting time in the cycle to consider leveraging. Perhaps some cheaper stocks around but so volatile.
My thinking is that given the LICs favoured around here and historical dividends – you are basically needing a yield of 3.5% plus franking to offset a 5% interest rate and hoping that you achieve capital growth in that time to make it worth while – is that about right?
Thanks again!
Thanks SJ, glad you enjoyed it!
I think the volatility is to be very much expected in the sharemarket – it’s more unusual when it’s not volatile! If that part worries you, then maybe using debt isn’t the best idea?
Yes you’re pretty much right, your return needs to beat the interest rate. I think that’s very likely over the long term, but in the short term prices can go anywhere as we know. Yields on the old LICs are over 4% currently, and with franking the yield is around 6% gross. Plus growth in dividends over time leads to a pretty attractive long term return in my book. As for using debt to buy them, from the comments here it’s pretty clear it’s very much a personal choice 🙂
I think the key question to ask as far as the numbers go is: “When do you expect the yield-on-cost to exceed the interest rate?” At the start, the yield-on-cost is simply the spot yield, and that may well be a little bit below your interest rate. What you want, if borrowing, is for dividends to (hopefully) increase, as time goes by, meaning that your yield-on-cost should, at some point, start to exceed the interest rate. So (as Peter Thornhill would advise) don’t get too hung up on spot yields.
Agree PT. There are very few occasions where the yield-on-cost exceeds the interest rate from the outset – usually after a prolonged bear market. That’s a no-brainer. On other occasions, you have to make a judgement based on sensitivities (dividend growth rates, future interest rates, etc). I think Dave’s point is well made – focus on building a strong cashflow base first (from passive investments) and then that base gives you more options – one of which is to use moderate leverage to build equity. So many people seem to want to build the equity first on the strength of their active incomes. This is such a risky play these days. If that active income is compromised in some way (TPD, illness, job loss). their risk profile is also compromised. But then again, this sort of “equity first” thinking usually stems from a mass propaganda machine.
I like this very much 🙂 It requires people to think deeper. Thanks for the reminder, Peter T.
Hi Strong Money,
Thanks heaps for your articles – I’m loving reading them, plus they are informative. Keep up the great work.
I have a question about these statements:
“You can only claim your interest cost against the investment income you generate by using that debt!” … “Hence, your total cost of debt is still 5%!”
So on a loan of $10,000 you’ve paid $500 interest, but earned $500 income. On top you’ve receive 30% back in franking credits, then (assuming your tax rate is 32.5%) you paid 2.5% tax on the income. Therefore you are down around $12 (approx). But in your example you’ve said the cost of debt is 5%, so I am a little unclear what you’ve meant by that. Are you able to clarify?
Thanks
Thanks for sticking around and reading them Mark!
When I said cost of debt is 5%, it was just another way of saying 5% is your true interest rate to benchmark against in that scenario. I think in your calculation you’re focusing too much on the franking rate vs tax rate. Here’s how it looks in dollars. Interest and income are the same, that’s correct. But the franking credit is worth $214 and tax needs to be paid on that at your own rate, so taking away 32.5% tax, leaves $144 of franking credits remaining. This will come as a tax refund.
You can see why I used gross percentages to make it easier. 7% gross yield, less 5% interest, equals 2% taxable income etc. Hope that makes sense 🙂
Another excellent article Dave. Very well done. Do you or your readers know which institutions are offering the kind of flexible LoCs we need for the Debt Recycling strategy? I’ve asked a few institutions (non-Big4) and their LoC has interest rates typically around the 5% mark but perhaps more importantly, the LoC offered is NOT flexible but fixed, so you might have to go through a re-financing pa-larva all over again if you wanted to increase the LoC to buy more income-producing shares as the equity in the house increases. I’m not sure if Debt-Recycling is for me but I do want to find out more… PT advocated starting with a small (or minimum) LoC and increasing from there via the flexible LoC. Grateful for any recommendations…
Keep up the cracking work Dave; you’re a legend!!
Cheers Jeff, great to hear you liked it!
From memory, I think the most flexible facility is one with a ‘Master Limit’, so that’s what to look for. I know AMP offer this and perhaps St George? But I think at least a little admin is involved in most LOC or debt recycling cases. Just part of the cost I guess. But if the admin is too much I’d just go for a regular home loan to get the cheaper rate.
To increase the overall debt as the property increases will always require a full application these days, as far as I know there’s no way around that. In the end, for some it’s not worth the hassle.
Hey Dave, I love those Buffett quotes:
“If you’re smart, you don’t need it. And if you’re stupid, you’ve got no business using it”. Also, “debt is the only way a smart person can go broke”.
I’m often tempted to leverage into stock investments, and can see on paper that it can be a sensible thing to do in the right circumstances, but I try and stay away from it for the very reasons quoted above. Agree with you you need to focus on savings and cash flow, and I probably have plenty more I can do in that area 🙂
Cheers, Frankie
Thanks for sharing that Frankie. There’s definitely something to be said for keeping it simple and not adding any unnecessary risk with leverage.
I’m not sure why a P&I where you paid the minimum monthly and invested the rest would be seen as less risk or be any ‘safer’ than maxing LOC.
In both situations wouldn’t you have a similar amount invested and have a similar pile of debt, you would just miss out on the tax benifits the debt recycling offers.
This is where the behavioural aspects come in which are underappreciated. For one the person knows the debt is only for their house which is usually a much more relaxed position to be in, and on top of that the debt is regularly reducing. Whereas if the debt is for shares and it’s been maxed out as you say, that’s likely to cause significant stress for many people in a market crash scenario. Humans are very strange and irrational beings and what sounds logical on paper often doesn’t work well for many in the real world.
But by all means people can knock themselves out and leverage up as much as they want. I’m just trying to be realistic and come at this topic from a number of angles and offer considerations that others haven’t.
Wow what a revelation on LOC debt recycling. thanks for all your research.
I was surprised by the fact that you can only claim your interest cost against the investment income you generate by using that debt.
I’ve read PT’s book and read the below link from ATO but both do not appear to clarify that important detail.
https://www.ato.gov.au/Individuals/Income-and-deductions/Deductions-you-can-claim/Interest,-dividend-and-other-investment-income-deductions/
Is there a link to ATO or any other govt website that explains this part of the tax deductibility clearly?
Thanks again.
Sorry I might not have said that the right way. What I meant was you can’t just say ‘hey my loan is now tax deductible so my true interest cost is only 2.8% instead of 4%’ which I see all the time – it doesn’t work like that. And also many people think they can borrow money and then invest in AFIC and use the DSSP where no tax is payable on dividends and then proceed to claim the interest costs on their borrowings – that’s not allowed. The point is your investment needs to generate an income.
You’re right that if shares are negatively geared, it can offset other tax just like property. Hope that makes sense now, apologies for the confusion!
Hi Dave,
Good article. Thank you for putting in the time and sharing your viewpoint. I am enjoying reading your blog.
One clarification that may help a few readers. Regarding Dividend Reinvestment Plans, in the ATO’s eyes tax is payable on the dividends regardless of them being reinvested automatically via a plan. https://www.ato.gov.au/law/view/document?docid=ITR/IT2285/NAT/ATO/00001
That is, they still consider the dividends income so you can deduct related interest expenses.
Cheers,
Alex
Thanks for that Alex. Yes of course, dividends are classed as income even if reinvested – I’m sure almost all readers understand that, but good for reference just in case 🙂
And I appreciate your other tip – the sentence reads much better your way!
My mistake, I was not aware of the distinction between Bonus Share Plans and Dividend Share Substitution Plans as opposed to Dividend Reinvestment Plans.
Very interesting that a couple LICs have special rulings to operate opt-in BSPs and DSSPs that don’t count as income. Thanks, I learned something new.
All good Alex!
Yep it’s certainly an unusual but attractive feature of those LICs, which may suit an investor depending on their situation.
Hi, how come you can’t borrow money to invest in AFIC with DSSP and claim the interest costs as a full deduction? Isn’t the tax ruling that the bonus shares from DSSP are not part of assessable income and only attract CGT? Therefore, wouldn’t you simply deduct your interest payments from your total income, of which would not include any dividends or value of bonus shares under the DSSP from AFIC?
https://www.ato.gov.au/General/Capital-gains-tax/In-detail/Events-affecting-shareholders/Specific-events—previous-years/Australian-Foundation-Investment-Company-Limited-(AFIC)–bonus-share-plan/
Hi Cam. You’re correct that it is not assessable income, but that’s exactly the reason you can’t claim interest costs against it…because for tax purposes you’ve earned no income. You can only claim interest costs if you borrow to invest in an income producing asset.
From this page – “If you borrowed money to buy shares, you will be able to claim a deduction for the interest incurred on the loan, provided it is reasonable to expect that assessable dividends will be derived from your investment in the shares” – since there is zero assessable dividend income by design, the interest would not be deductible.
Thanks for the reply! Really appreciate your effort to responding to all of the reader’s comments.
I’m gonna be shameless and admit I’m still a bit confused.
Okay, if the shares bought on LOC are negatively geared then it’s obviously tax deductible, I get that bit.
My previous understanding was that if the interest on LOC is 5% (eg. 5% on 200k LOC loan = 10k) then $10k would be tax deductible from my salary of 100k. Hence then my taxable income becomes 90k.
But after reading your article I assumed my understanding was incorrect. So I did some googling including the ATO website, and I couldn’t find anywhere that clearly states that my understanding was wrong. Reading your comment and re-reading your article it seems that only if the investment is negatively geared it is tax deductible?? Please lead me to the right path or a link to further understand this concept.
Your line “If you don’t understand this, debt recycling is not for you.” got me HAHA. Maybe debt recycling isn’t for me…yet!
Thanks so much again.
Cheers.
No problem, hope it’s helping readers rather than confusing them!
Again, it doesn’t work like that. The interest is only tax deductible because you’re earning an income with it. Think of the investment numbers as separate from your wages. The investment income and any costs incurred in that income – calculate these by themselves. So you might earn $10k dividends and pay $10k in interest, your net income is zero.
You get no tax return and pay no tax, because the extra income earned if $0. In that case, you’d expect the growth would make up for it, because that’s the other part of the equation. Your salary is still taxed at exactly the same rate as before. You have no ‘losses’ to claim as would be the case if your interest was more than your dividends. And if your interest was less than your dividends, then you may owe some tax (depending on franking which complicates it again).
Is that any better?
If this is the case then why do property investors get a free lunch in being able to apply interest accrued servicing loans over their investment properties against their regular income?
Why would shareholders not enjoy the same benefit?
Sorry for the confusion. Shareholders do get the same benefit. My point was that many people miss that your interest costs are offset against your investment income FIRST, not just straight against your salary income as Derek has assumed here. Also others think they can use the BSP from AFIC and claim interest costs, but that’s not true. Your interest is only tax deductible if your shares produce income – investing in shares that pay no dividends means the interest is not deductible. I probably didn’t say it in the right way, but I wanted to make the point.
To clarify, the tax outcome of the investment is calculated FIRST, and then any cashflow losses are allowed to be offset against regular income.
Thanks for the clarification Dave. You raise an interesting point regarding income producing shares though (https://www.ato.gov.au/Individuals/Income-and-deductions/Deductions-you-can-claim/Interest,-dividend-and-other-investment-income-deductions/) and I was not aware of this but it makes sense. Again, comparing to a rental property the interest is not deductible if the property is not available to rent/produce income.
Food for thought. I have recently applied to remortgage with a separate investment loan with the view to invest in dividend shares to cover the interest payments. The above gives me more reason not to sneak any of it into speculative mining shares! I’ll save my play money for those!
Thanks again Dave. That is definitely better.
Makes sense!
Cheers.
Thanks for asking the question, Derek. I had the exact same one.
I agree the ATO documents don’t make this important clarification clear when they talk about the tax deductibility of interest costs.
Hi Derek,
As a point of interest, lets just focus in on the way you outlined the deductibility of investment interest for the benefit of anyone else who’s thinking this way;
“My previous understanding was that if the interest on LOC is 5% (eg. 5% on 200k LOC loan = 10k) then $10k would be tax deductible from my salary of 100k. Hence then my taxable income becomes 90k.”
If this were the case then you could logically come to the conclusion that Dave pointed out was wrong, ie:
“My interest rate is 5%, and I’m on a tax rate of 40%, so my investment loan is really costing me 3%, because it’s tax deductible.”
In your example the interest costs $10k, so $10k is taken from your income. You no longer need to pay tax on that income. The tax would have amounted to 40% (using Dave’s example), or $4000, so this will be refunded, leaving a shortfall of $6000 – or, 3% of your loan value ($200k). Your out of pocket cost would be 3%, and this could be confused as your true interest rate. This is not how it works. However, I can see how it’s an easy mistake to make if you’ve never walked through it.
Happy investing.
Appreciate your effort in helping me to grasp this. It’s making more sense now. Cheers.
Fantastic article, well summarised, easy to understand and really balances both point of view and the pros and cons. Very much helped me decide on if I would look at it more seriously as an option.
For me, being debt free is always going to win over perfecting a strategy when the variables over the long term can go so so many ways and are often are outside my control.
Thanks for taking the time to put it together!
Thanks for the feedback Chloe, I’m really glad it helped you 🙂
I just took 90k out from equity and used it as a deposit for a IP.
My question is, could I of used that equity and put it all into a LIC instead of getting a line of credit?
Hey Ando, yes it does sound like you could have bought shares instead of putting it towards a property.
So would this still count as debt recycling?
Well, not quite. It’s just taking out new debt to invest with. If you use then use the income from the new investment to help pay down your mortgage and then take out the equity again later to repeat the same process, then that is what’s considered debt recycling. You’re using the process to help pay down personal debt (home loan) and convert it into investment debt – hence the ‘recycling’ part. Hope that helps Ando.
It would be good if you could pose these sorts of issues to Peter Thornhill. I’d like to know how he would respond. He seems to promote this exact idea.
My guess would be that all these assumptions are for the present time or for more negative scenarios that are again assumptions. He would point to the fact that historically LIC’s have marched on like the companies they are invested in, year on year and despite dips and rises in market value they have continued to deliver a growing income stream. A $100k investment made now my deliver $4k in dividends today, but in 15 years time they might be delivering a 8 or 10k income. That changes the figures dramatically.
It all comes back to your expectation for total returns. The dividend growth is implied within the returns I have used – 4% yield, plus 3% growth. It has not been ignored at all. You may like to work on a higher growth rate of course.
It’s absolutely true that dividends will continue to increase over the long term, I would never suggest otherwise. But I don’t think I’ve given an overly negative scenario considering that interest rates are about as low as they’ve ever been making the numbers look quite good.
I’m trying to give an overview of everything to consider, because it’s clearly not a free kick as some people trip themselves up with the behavioural/psychological aspects of using debt for share investing, or only reading some overly optimistic material on it.
It’s likely Peter would respond with ‘it can definitely work if people know what they’re doing and keep it simple’. And I would agree with that, there’s just quite a bit to consider first I think before jumping in thinking it’s a guaranteed win.
Hi Dave,
Really appreciate your articles (and the community responses). Was wondering if you had any further insight into actually setting up the LOC debt recycling system with a bank (beyond the excellent description above).
Here’s the story: I’ve called around to AMP and State Custodians, but the sales team for both seem totally perplexed by the concept of setting up a separate ‘investment account’ to transfer/redraw equity paid down into the principal home loan account. Both said that wasn’t how their LOC products worked and that I would have to apply to have the LOC increased each time I did this (i.e. a full loan appraisal), which kind of defeats the ease of use of the LOC approach. I’m sure this is not how it is supposed to work, have you (or anyone else reading with an LOC debt recycling setup) run into this confusion at the bank and have any tips for me to ease the pain of setting it up with them? Seemed they didn’t understand the concept :/ Or maybe I’ve been unlucky and gotten hold of someone with zero experience…
Background context: I have set up debt recycling on my PPOR using the Interest Only split loan approach. Over the last year since I started my loan I have recycled my debt twice to increase my equity and have redistributed –> investment account –> LICs. However this system requires a full loan re-appraisal (documents etc.) each time I do this, which is killing me more than the miniscule interest I’m saving. So looking for a simpler (LOC) approach. Would be refinancing.
Thanks,
Jake
Hi Jake,
Anything other than a plain vanilla home loan seems to confuse the customer service lines I’ve noticed. I’m not sure I can make sense of it to be honest. My thinking was you simply need a line of credit split into two parts, and as one part is paid down, it also becomes available to redraw from the entire facility, up to an overall limit, which is whatever your maximum allowable loan is with them.
There’s some very savvy mortgage brokers on the propertychat.com.au forums. They’re pretty helpful at answering people’s questions too, so I’d ask in there also. It could be the case that I’ve got it wrong and that’s not how a Line of Credit works – which could definitely be the case as I’ve never set one up. I think the guys there could certainly tell you the reason behind it and where to go from here.
Definitely easier with simple split loans as you’ve experienced. But the whole re-applying thing is a bit ridiculous considering your debt level will remain the same. Hope that helps and you get the setup you’re after!
Interesting. I have a LOC set up against my PPOR for other reasons. Similarly, when increasing the limit I had to apply again and go through the process. Years ago it was fairly easy, but has clearly tightened up with the whole tightening of the lending market. More paperwork, longer time to get it through.
There is a product called a portfolio loan, which give you that simplicity. An entire loan against a property can be split into individual loans. The sum of each loan totals the same. If you build equity you can increase the LOC component facility and reduce the other components. With the portfolio facility you can change the individual balances by yourself without reapplying. An example with NAB is https://www.nab.com.au/personal/loans/home-loans/nab-portfolio-facility
Note the fees and rates are generally higher than simpler facilities – you are paying for the convenience. I m sure you can get discounts on the rates on websites
Thanks for chipping in here SJ. I think there’s a few banks that offer similar products, CBA and AMP come to mind.
Seems like the line of credit approach is probably the least feasible these days for the reasons brought up and the easier you want it to be, the more you’ll likely have to pay – haha banks!
Hello Jake, not quite the same scenario as yours, but here’s how me and my wife do LOC.
We have our own home fully paid off except for approx $500 which we keep at that level to allow us to have two LOCs separated into our individual names for tax purposes. The LOCs are for $120K each and are 5% interest.
We buy shares and LICs and ETFs during market dips using the LOCs , we borrow conservatively , normally only 10-40 thousand to buy bargains and then we aggressively repay the LOCs during times when the market is rising . The reason we have $120K x2 LOCs is so we have more ammunition to buy more aggressively during a GFC style event where we have a greater margin for share price gains and very good yields.
Good advice is to borrow conservatively and don’t put yourself in a position where you have to sell during a downturn.
What type of entity do you have everything in? Is your home loan in yours and your wifes name? you have an LOC in each of your names. Do you then have share portfolio in each of your names? Does your structure allow you to claim the interest of the LOCs?
Hello Whit, we DO NOT have a trust. Our home loan is in both our names and is ALL BUT paid off ( we keep a balance of a few hundred dollars to have access to the L.O.C.
We have a LOC each in our individual names. We have seperate shareholdings/commsec share accounts as we earn similar incomes and in retirement we can individually earn dividend income with seperate tax free threshholds.
As we only use the LOCs for investing in shares LICs , etfs ( important- you must be able to prove to ATO the purpose of the loan) because of this we claim the interest on the LOCs against the income from the investments.
Regards
“You can only claim your interest cost against the investment income you generate by using that debt!”
I believe this is incorrect.
As far as I can tell you can negatively gear shares the same way you would with a property.
https://www.afr.com/personal-finance/labors-negative-gearing-plan-could-hit-margin-lending-20160216-gmv2f8
Oops thanks for pointing that out. I’ve worded that wrong. My point was supposed to be: You claim your interest against the investment income you generate first… then any losses can be offset against other income.
It’s targeted at people who assume their interest cost is 5% and it’s tax deductible debt so they assume it’s only costing them 3% if their tax rate is 40% – which is obviously wrong, it needs to be offset against investment income first, it’s not a slam dunk tax deduction as some assume.
Thanks again, will fix the wording now.
Does the house, LOC and share portfolio all have to be owned by the same entity? Or can you have the house, LOC in your own name and share portfolio in a trust?
The debt and the share portfolio would usually have to be in the same name for the debt to be tax deductible. But when there’s a trust involved, there may be some arrangement where the trust can borrow the money from you and buy the shares (since I assume you’d be a beneficiary of the trust) but I’m really not sure about that one – you’d have to ask a tax expert.
So if I invest in AFI and make use of the Dividend Substitution Share Plan, I can then claim the full investment loan interest on tax as a loss?
Never mind you already explained that in a comment above:
“Also others think they can use the BSP from AFIC and claim interest costs, but that’s not true. Your interest is only tax deductible if your shares produce income – investing in shares that pay no dividends means the interest is not deductible. ”
I guess that makes sense. Anyway thanks for this it was an interesting read.
That would be nice, but unfortunately a bit too good to be true 🙂
Thanks for reading Tim.
Hey Dave, going through your older blog posts at the moment.
Looking at the interest rate of 6.28% p.a. for a LOC with CBA, and without having checked other banks yet, it may be simpler for some people just to buy LICs on the side every month and then pay off the mortgage, without the line of credit. Well I guess every case is different and there many variables to consider, that’s how I see it from my current circumstance.
Cheers
Hey mate, that rate is terrible in the current environment! There is no way I’d bother with a line of credit when there are rates around 4% or less for regular home/investment loans.
Curious if it would be better to have DRP turned on rather than redirecting income to the home loan?
I guess this way you wouldn’t be reducing non deductible debt as fast but you’d be building up your share portfolio quicker and also dollar cost averaging with more frequent share purchases?
Interesting comment Will. You could do that, but then it’s not debt recycling, it’s just buying shares. The idea is it’s more tax effective to pay down your loan because you can take the cash back out quickly and hey presto that part of the loan is now tax-deductible. More to it than that obviously as the post explains, but that’s generally the idea.
Purchasing shares monthly without debt recycling would have lower after-tax returns (less effective) than say 6 monthly by doing debt recycling in chunks. The tax deductibility of interest costs would suggest this. Hope that makes sense.
I have read through most of these comments and its all really interesting, thanks for the resource. I’m in a situation where i have my mortgage under control and have approx $90 000 that i could redraw to fund an ETF investment, but I’m with loans.com.au for my home loan and I’m not confident they will allow splitting the loan, although i am waiting for their response.
Is it possible, I just redraw, make the investment, and work out the interest myself, based on the rate? Is that too simple to work?
Cheers.
Hey Nick. It’s possible to do that, but not recommended. It’ll be a headache as each month has a different amount of days (so different interest charged) so you’ll have to work out the amounts every time. And if it’s a P&I loan it becomes near impossible as the loan is paid down each month you won’t be able to tell how much interest is charged on the investment portion and how much on the rest of the mortgage. A separate interest only loan is really the easiest way to do it. Creating separate loans is not really a big deal so I can’t see why it’d be an issue for them. Hope that helps.
Thanks for the reply Dave, and as it turns out it is no big deal to the the loan split.
Another question, whats your recommendation for investment then, to make it most viable? I obviously need to be earning a dividend, are there a few names you would prefer? I like the sound of the Vanguard ETF’s, from what i have read so far.
That’s good news Nick. Whatever investment you feel happy owning for the very long term – Vanguard index funds are certainly a good choice 🙂
Hey Dave, I’m really enjoying working my way through your posts. I’m pretty new to the FIRE concept – though I’m 56 so not that far away from traditional retirement age ????????
I’ve been considering debt recycling and not sure if it would be a crazy thing to do at my age. I have four investment properties which I’m planning to sell over the next few years. I have a PPOR mortgage around $275K, and more than enough in my super to pay it out in a few years when I do retire. I’m also salary sacrificing 15%.
I was fortunate to get a large pay rise earlier this year, so I now have a spare $10K per year to play with. I was deliberating whether to pay the mortgage down or buy shares, and settled on shares while interest rates are low. Perhaps switch over to chipping into the mortgage when rates increase.
So as I’m going to be buying shares anyway (LIC & ETCs), I figured maybe I should do it via debt recycling instead. I’d be looking at doing it P&I for all loans, and not increasing my debt limit to do this. I have 3 years left in a fixed rate, so would have to wait to refinance. My broker has told me I can do that as I’ll still be working. I’d be looking at throwing my excess savings into the offset, then when t reaches $10k do the split/transfer to new loan, and use that for shares – and reduce the PPOR loan by the $10k of course. I was thinking to keep DRP instead of directing it to the offset like one of the other guys above said, particularly as my dividend income is so tiny now, and I can easily service the loans on my current income, particularly as I’m not increasing my limit. In 8 years when I retire I will pay the whole loan out of my super and keep the facility open for future possible purchase – which is what I believe Peter Thornhill does.
What are your thoughts on this? Am I mad to even consider it?
Thanks!
Hi Jane. Great to have you here!
You’re definitely not mad, it’s always worth considering different options 🙂
OK, so retirement is not far away, you’re selling your investment properties and paying off your mortgage. This sounds like things will be nice and simple. Given the timeframe and given that you’ll be essentially debt free at that point, I don’t really see a big advantage to debt recycling in this scenario.
I’d probably opt to keep it simple and add as much cash as possible to the share portfolio. The income from this will grow nicely and as you sell off your properties and/or pay off your home, the cashflow situation will be even more improved – you’ll have no debt and hopefully a decent income stream from shares! Hope that helps.
Great thanks Dave – that does make sense ????
Hi Dave, would I be correct in thinking that this doesn’t make any difference to someone working in the not for profit field where their mortgage / living expenses are already tax deductible? Cheers.
I mean, I could pay extra into my PPOR redraw (mortgage at 3.57%), then use it for investment when I’m ready to and still have the advantage of the salary sacrificing that comes with NFP employment.
Hey Jodes. I don’t know much about those types of arrangements to be honest, but sounds like you’re on the right track. If those things are already tax deductible there prob isn’t much benefit to debt recycling right now.
Hi Dave,
Long time reader, first time contributor here. Really enjoy your webpage and all it’s information and insights.
Would appreciate your thoughts on our current debt recycling strategy.
My wife and I are 50ish with two (expensive) teens in Sydney. Our home is valued at $1m.
We’ve been debt recycling for the best part of 8 years through an IO ( 5%) line of credit of $90k which we are comfortable with. Current returns pay for the cost. We sold out of managed funds ( expensive ) about two years ago.
Our investments are made up of about 15 blue chip stocks $30k, Vanguard ETF’s ( VAS, VGS & VHY) $5Ok & LIC’s ( AFI, MTG, ARG, BKI & AUI – Thanks for the tips !) $20k. Total portfolio cost $102k valued at $119k.
Our P&I home loan is split in two – The offset portion was paid down and redrawn to buy $15k of LICs, offset by $20k in cash, which we now consider as a side offset investment loan. ( Further $11k redraw limit ).
The non offset has $19k to pay out the home loan ( Further redraw $70k limit ).
My wife and I are both working full time at this point and we have $40k in tax effective Education Fund to pay for school fees. We have combined $350k in super.
I guess our question is, if you were in our shoes, would you continue to;
1. Pay down the non deductable / non offset home loan and then
2. Redirect all funds toward the investment offset loan with the view of churning that loan to buy more LICs / ETF’s through the investment loan or
3. Pay down the investment loan or
4. A combination of 2 & 3
Another thought was to take some profit while the market is up out of the share portfolio in order and pay out the mortgage, leaving investment loans only.
Any thoughts would be greatly appreciated.
Love your work!
Cheers
Hey Daz, great to hear you’re enjoying the blog.
If I still had some non-deductible debt I would pay that down first. Then decide whether you’d like to redraw those funds for investment I suppose – that’s totally up to you depending on how much debt you’re happy to have, or if you prefer less. Sounds like you have plenty of room to redraw and increase your portfolio, so that’s your call. I don’t see any benefit to paying down the investment loan as well right now unless I wanted to use the investment income to live on pretty soon.
With most of these things, there’s no real right answer.
Thanks Dave,
Appreciate your thoughts…A number of variables to consider.
Cheers
Hi Whisk,
You are correct that Part IVA is an overarching anti-avoidance measure that has been around for 40 years. Part IVA hangs on the premise that the taxpayer entered into a transaction for the dominant purpose of securing a tax benefit. Provided that there is reasonable commercial justification for entering into a transaction, Part IVA does not apply. In the case of debt recycling, as long as you use the borrowing to acquire income-producing assets, the commercial nature of the transaction is justifiable. Just think negative gearing of residential property. Although the merits of negative gearing have come under scrutiny in recent years, Part IVA rarely gets a look in. Why? The debt is being used to purchase an income-producing asset. Moral of the story: Never enter a transaction for the tax benefit.
“Never enter a transaction for the tax benefit.”
That should be the 11th Commandment…
If I’m using redraw to debt recycle and I’m keeping my records for the ATO does anyone know how this would work?
Example:
Redraw $3000 From PPOR and transfer to broker account
Invest as much as possible into chosen ETF however with the share price and brokerage it only equals $2950
Is the spare $50 considered personal funds now or is it tax deductible?
I found a legal ruling that probably fits the bill and answers my question.
In Kidston Goldmines Ltd v. FC of T 91 ATC 4538 at 4545-6; (1991) 22 ATR 168 at 176-7, Hill J. stated:
‘In most cases, the purpose of the borrowing will be ascertained from the use to which the borrowed funds were put…
To be deductible the outgoing, or in a case of apportionment a part of an indivisible outgoing, must be seen to be incidental and relevant to the activity which is directed to the gaining or production of assessable income. In the normal case, the fact that funds borrowed have been borrowed for the purpose of that activity and can still, in the year of income in which the deduction is claimed, be seen as having that purpose, will lead readily to the conclusion that the interest will be incidental and relevant to the income producing activity. Again, in the usual case the application of funds for an income producing purpose will demonstrate the relevant connection between the outgoing and the income producing activity. Indeed there is much to be said for the view that the tests of purpose and application of funds are but two sides of the one matter.’
Hey Justin. Interesting question.
My non-expert opinion is it’s likely to be fine, as you would be likely investing it very soon after anyway in the next purchase. Add to that, the fact that interest on $50 is going to be about $2 per year. Given there is no contamination of funds and all effort has been made to do the right thing, the relatively small amount of time that the $50 is not invested yet, should be deemed as acceptable.
The bigger issue is hopefully you’re redrawing from a separate loan account and not just part of your normal home loan. Or it gets messy with having to apportion interest due to amount of days in the month/year that you invested, plus any time the rate changes, you will have to recalculate. Best just to get a separate split loan if you haven’t already. I’ve heard some banks will do this in $10k lumps.
Hi Justin,
The crash brought me here! I’ve nearly paid off my house and have a bunch of cash in redraw. I’m on the fence whether to split 100-150k off it and buy a parcel of a200, because I hate debt, but to quote Idiocracy, “I like money”.
My questions is, why did you take out of the redraw instead of getting a split loan like suggested? Was it not an option?
Cheers,
Neal
Hi Neal,
My PPOR is currently with Ubank and they do allow you to loan split by submitting a form but the processing can take anywhere from 2 – 4 weeks to go through. If you don’t want to run a spreadsheet that apportions things I would recommend a split, you can’t go wrong with that.
My reasoning behind using the redraw is because I can more regularly take money off of my home loan to put into shares without having to keep asking the bank for a further split.
Haha “I hate debt, but I like money” made me smile 🙂
I’m using the Apportionment calculations method found here:
https://www.ato.gov.au/law/view/view.htm?docid=TXR/TR20002/NAT/ATO/00001
Running a spreadsheet that apportions everything which works for me at present. Allows me to more regularly debt recycle each pay if I have the funds and not have to wait for the bank to process splits all the time.
Okay, if it’s working for you that’s what matters! Nice work.
Hi Guys
What is the minimum amount to start the debt recycling strategy?
currently we have 2k in our redraw account. Can I start with 2k for now?
Cheers and stay safe always
Conp
Hi guys,
Apparently with WBC, minimum amount is $10k..
Regards
Conp
It’s probably the same everywhere. Re-examine your personal finances and see where you can save more to get to that $10k threshold sooner. All the best.
Hmmm… Conp, I would re-read the posts because what you are suggesting does not seem to constitute debt recycling. Pay particular attention to the figure from Peter Thornhill which illustrates the process. You borrow money for your PPoR then take out a Line of Credit against the PPoR to buy shares. The dividends from the share are used to pay down the home loan and the interest on the LoC is tax deductible. And so it continues. I’m no expert, but I suppose in your case, you could re-finance your home loan and take out a LoC.
Happy to be shouted down of course by more knowledgeable readers!!
Hi Jeff
Thanks. $10k is the minimum amount for WBC to start debt recycling.
I waswondering what is the minimum for CBA, bankwest as well??
Regards
Conp
hi all,
I started by reading Peter Thornhills debt recycling set up but didn’t fully grasp it first time.
After finding myself here i think all the comments have cleared up heaps for me. Thanks to all who posted.
I’m poised to invest in the share market and while the fully leveraged style that PT uses will not meet my conservative nature , i do think its a great idea to debt recycle. i just wanted some thoughts on the actual loan set up and if it really matters what you would use as long as borrowing is spent on dividend shares.
I have 2x variable interest loans on my PPoR. Fortunately one is paid down to zero. Could i simply start using the zeroed one to start a portfolio ( 120k available funds). Question being , do i need a LoC , ‘portfolio facility’ mentioned earlier , or other specific loan to start the debt recycling cycle or will it work with the cheaper facility i already have available?
Does debt recycling work with personal loans to be invested into LICs?
Yes, technically it would work with a personal loan. But because personal loans tend to have very high interest rates (7-12%) you’re better off getting rid of those loans entirely before investing. Also paying off high interest debt has a guaranteed return with no risk!
Hi,
Thanks for the great article and info!
Under the debt recycling strategy:
1. Can you sell and buy different shares/investments within the investment portfolio, and still maintain tax deductibility of the investment loan?
2. What value does the investment portfolio need to maintain, compared to the investment loan?
Ie. If the investment loan is paid down from 10k to 5k, can I sell my investment portfolio down to 5k, and maintain tax deductibility on the 5k loan?
Cheers, David
Thanks DQ 🙂
1. Actually, I’m not 100% sure on this one. My guess is, no. The asset which the loan was for has been sold, so unlikely to be still deductible, even if the money is reinvested. But best to speak to an accountant about that.
2. This is also a tricky one. The value of the portfolio is irrelevant compared to the loan. The loan has already been paid down to $5k, and then you’ve sold half the investment. So my guess is, no you probably can’t claim deductibility on the remaining $5k after selling half the investment. But again, an accountant can answer that as it’s a bit unusual.
I would LOVE a podcast on this topic Dave 🙂
Great article Dave,
I only have 1 question. If we are using ‘Debt Recycling with Interest Only Loans’ from our PPOR.
Isn’t this will trigger CGT when we want to sell our PPOR?
Correct me if I am wrong, the reason is because we are using PPOR equity to make income producing asset.
Regards, choky
Hey choky. No, you won’t need to pay CGT. You’ve sold your residence, not the underlying investments which are earning returns. It’s the underlying investments which are taxable, the property is only used as security for the loan. The main issue there is, you usually lose interest deductibility on the loan, unless you transport the home loan to a new property by doing a ‘security substitution’ with your bank (google it for more info). Hope that helps.
Hi Dave,
Thank you for your explanation. It does make sense now.
Please keep the blog posting. Love it.
Regards, choky
Hi,
Would be great if you could cover capitalised interests, as it sounds like all investment income is directed towards the ‘bad’ debt and monthly interest on the ‘good’ debt is not paid at all.
Does this create a tax benefit resulting in the ATO denying the deduction on capitalised interest. I’ve read mixed opinions for both sides.
It also highlighted a gap in my understanding of claiming deductions for interest on investment loans – that you must have paid the interest on the investment loan to claim it as a deduction. The capitalised interest scenario (where you haven’t been paying the monthly interest charge so you are getting charged interest on interest) has got me thinking that you could claim the total interest charged (not paid) as a deduction.
Thank you!
Hey Gary. They key point here is, you still are paying the interest owed on the investment portion of the loan – it’s not capitalised. It’s usually setup as interest-only or even principal and interest. I’m not advocating to let the interest capitalise, as my understanding is (as you said) that would not be allowed by the ATO and the deduction would be denied.
Great read Dave – thankyou.
Stupid question – not sure if this is debt recyclin or not but we aren’t paying any interest on our PPOR mortgage as we have the balance sitting in offset. We are thinking about accessing a chunk of this money and investing in ETFs. Is the simplest way to move a chunk of it sideways into a split loan and then claim the interest as a deduction at tax time? Thanks I’m advance.
Hey Aaron. If I understand you correctly, then yes, you could have the bank split part of the loan for you, pay off that chunk and re-borrow the money back out to invest with. Then when you declare your income from the ETFs at tax time you can also deduct the interest expense on the loan you used for it. Hope that makes sense.
Thanks Dave for this. Can this be done without splitting the loan with the bank? currently NAB and it’s bloody hard to split loans 🙁
Which banks are best for debt recycling? also which LIC / ETF do people normally go with. Off the bat, I am thinking of just going A200 or VAS
Hey Mike. It can be done, but then it can be messy as you’ll have to calculate the interest yourself (since the home loan and investment loan will not be separate). If you go this route, just keep good and accurate records for tax purposes. And I would stick to using precise whole numbers like $20,000 or $50,000 etc. which will make it easier to calculate the interest.
Most banks offer split loans of some sort, but some are more flexible than others, not sure who’s the best. And for investments, people typically choose what they are already investing in already, or would like to invest in. So that you’ll have to decide for yourself. Make it something low cost and diversified that you want to hold for a long time.
Thanks Dave. Great write up. Any thoughts on what happens if you move banks after you’ve set up the split loan for investment purposes? The underlying investment remains the same (in my case shares purchased with a split loan). But the record keeping is suddenly much different.
Dan
Yeah this is where it gets tricky. I’m not sure what happens in that case. I would ask an accountant about that one. If the loan is technically paid off with the existing lender (which it may have to be in the case of a refinance), then it may no longer be tax deductible since a new loan will be created. On the other hand, it may be fine since the loan is (in practical terms) just being transferred and the ATO can understand it’s still the same debt for the same purpose.
Hi, thanks for this helpful article. I am looking to employ a debt recycling strategy and was originally looking to use a mixed ETF and LIC approach (approximately 50/50). However, with some of the big, traditional LICs trading at a substantial premium right now, it has made the decision making about portfolio allocation a little more complicated. I am considering LICs currently trading at a more reasonable level such as MLT, AUI and WHF instead of AFI and ARG. Given the long term buy and hold approach needed here, maybe this is not a huge issue but I am conscious of buying at a significant premium. The answer might be to spread across to 3 LICs instead of 1 or 2 for example.
Also, with ETFs I have contemplated using a mix of VHY and VAS. I know these two ETFs go about things quite differently; I thought splitting across the two might bring the best of both worlds given the interest payable in a debt recycling approach. Do you have any thoughts on this?
Hey Blake. You’re right to not want to pay a large premium for the old LICs. I would honestly go with whatever you’re most comfortable with. I probably wouldn’t go with VHY though, as I mentioned in Question 1 of this post. Pick a couple of holdings that you’re going to be happy holding for a long time. Any combo of the options you mentioned should get the job done.
Has anyone actually employed this strategy successfully recently? I have been looking around a lot of lenders trying to do this and none of them seem to be able to do it. Their general line is that you cannot have two seperate loans secured against the one property, so you would not be able to do a split loan against the property to have part investement, part paying off home loan balance.
Would be good to hear other people’s experiences if they have managed to do this, and who the lenders were that facilitated this.
It’s a simpler strategy than it sounds. You’re simply accessing equity in your home after having paid it down a bit. It’s a normal P&I loan which also gets paid off over time. There’s nothing unusual about it.
Seems very much the opposite to me. Looks like a very simple strategy on paper, but it becomes very complicated once you actually try and implement it, mainly with all the lenders unable to give you a split loan, or allowing you to borrow more and use the equity in your loan for investment purposes . Would be good to know if anyone has actual real world experience with debt recylcing, as in my experience it has been a lot different to what has been written in the article.
I’ve done it myself, though we used the equity to buy investment property at the time. If you’re having trouble with the banks, I would go to a mortgage broker who can help you setup a split loan, because it’s really not an unusual request at all.
Hey Gabriel, we are currently with Ubank and they allow up to 4 splits just by filling a form (originally we refinanced with them , it was one variable P&I loan).
Thanks Dave, nice article and great detail.
I would like to implement this strategy.
I recently started my home loan with Westpac.
I called their customer care team to discuss this option, however they always talk about Line Of Credit Margin Loans.
Do you have any idea what this product is called at Westpac or is there any terminology that I am missing when talking to them?
There’s no special product, it’s just a split home loan. Tell them you want to split part of your home loan off to use the money for something else. Not a margin loan or a line of credit, both are too expensive. Thanks – I’ll actually be re-doing this article very soon to make it simpler and more practical.
Jyotsna, I’ve recently refinanced to Westpac via a broker, and am implementing debt recycling. The loan split we are using is Westpac’s ‘Fixed Rate Investment Property Loan’. Ignore the reference to ‘property’ in the loan title. They are happy for it to be used for share investing.
We have been debt recycling for a number of years (thanks Peter Thornhill). I think one of the things people get worried about is the concept of never going into debt to invest. A fair point, but we only ever invest what we would invest anyway – the tax deduction is icing on the cake. We do accept a reduced benefit though because we are on P and I and start with a full redraw split and slowly dollar cost average into investments over time. Our bank (ING) has had no issue with helping with various splits. I am glad we used an accountant beforehand though to make sure we had our ducks in a row.
Exactly. This isn’t about using more debt to invest with, it’s simply taking what you were going to invest and essentially moving the money through your home loan before investing it.
Great to hear it’s been working well for you Joce!
Hi Dave,
Another quality article as always, I think it would be beneficial to have a greater emphasis on the fact that for the interest to be tax deductible it must be an income producing asset (dividend paying share).
Also the ‘bad debt’ can just be decreased as the ‘good debt’ is increased one split loan instead of multiple splits and just apply to have the loan split amounts changed.
Cheers
Thanks Jake, appreciate it. You’re right, I’ll add that in there, cheers!
Hi Dave,
Timely update as I was just thinking about this yesterday..
Am I correct in assuming that the structure of the loan isn’t critical, i.e. you don’t necessarily need a loan split? If I have a simple P&I loan with unlimited redraw, can I simply deposit money to pay down the loan then redraw it straightaway to invest? This would then make the interest on that component tax deductible so long as I kept accurate records?
Hi Dan
id always recommend splitting the loan for the amount you want to debt recycle every time you DR (assuming u lump sum DR). it keeps the interest calculation nice n clean come tax time. my 2c.
Hey Dan, as DRS has said, you can technically do that, but it will quickly become a nightmare for tax purposes. Interest is charged daily and you need to know exactly how much interest for the month/year was related to investment and how much for your main mortgage. A split makes things incredibly easy since each loan has its own interest summary for the year 🙂
Thanks Gents, good advice.
I ran the numbers this morning and you’re right it gets quite complex when you consider every transaction influences the outcome.
It is also less efficient without a loan split as every time you pay down the combined loan, you are proportionally reducing the principal of the investment component, hence lowering the claimable interest.
Yeah it’s ideal if the split is interest only since it becomes an investment loan the goal usually isn’t to pay it down but to focus on the main home loan. Sounds like you’re onto it!
Great write up. Would you be liable for capital gains tax when you sell since a portion of the property equity was used for investment purpose?
Cheers Evan! No, it won’t affect the CGT status of your home. The physical home itself is not being used to produce any income, which is how the ruling works.
Thanks Dave, as always great.
For dept recycling purpose, assuming having another income in 37% tax bracket, isn’t international shares better than Australian ones? As international shares have higher growth and lower dividended which makes more tax saving possible.
Thanks! Well in one sense, lower yielding investments would produce a better tax outcome. But I would encourage you to invest however you wanted to invest in the first place, rather than changing your approach to get more tax savings. Keep the big picture in mind, tax optimising is a much lower priority.
Great article Dave, we just used this strategy, we were lucky to get done debt recycling, just a couple of months ago. We sold out our international and Australian shares portfolio, and we put the whole sum to pay down completely the mortgage. Then we redraw exactly the amount of funds to re-invested in ETFs. In fact, we were very fortunate to have enough funds on our portfolio to be able to do it this way.
KISS strategy
1) we bought a house using ppor loan
2) we sold shares and use proceeds to pay off the entire loan (but not close it)
3) redraw funds
4) repurchase shares (ETFs)
Outcome loan 100% tax-deductible
Hi Nordin,
When you pay down your loan in Item 2) and then re-draw the funds per Item 3), did you update the loan type from Owner Occupier to an Investor grade loan?
There would obviously be an interest rate adjustment in doing this. No doubt it was still a worthy exercise.
Thanks,
Jarrod
Hey Jarrod, there’s no need to change the loan type as the debt is still secured against your owner occupied property so it comes at the owner occupied mortgage rate. I’ve had splits for investing in the past on our previous home and the bank always charged us the owner occupier rate. There’s a chance this could have changed but I don’t think so.
Great! Thanks, Dave!!
Hey Dave,
I’m wondering your thoughts on whether this would be the same if you are borrowing extra, rather than just transferring funds from one loan to the other. I’m getting a loan set-up with UBank, and my current LVR is around 40%, so I am taking a bit extra out to supercharge my investment strategy. But once they found out I was going to be using the money for investments, they said I had to pay the investment rate. When I questioned this, saying it is still secured against a PPOR, they didn’t really provide a firm response but said they have to charge the investment rate on the investment side of the loan split. I’m not sure whether this is just them trying to get a few extra dollars out of me, or if there is a legitimate reason as to this rate. I would think in theory I am using the same strategy as paying down the loan and the redrawing into another loan split, except that I have already done a lot of paying down the loan prior to implementing the strategy.
Thanks,
Gabriel
Nice work Nordin, and sorry for the slow reply!
Hey Dave
I’ve gone through the comments but don’t think this has been covered.
What is the approach to paying off the principal of the split loan when it’s a p&i also, not interest only?
We’re looking to implement the month-by-month strategy.
As always, an excellent article written for the average punter.
Cheers
Hi Toby. I’m not sure what you mean? If the loan is P&I then the principal will be getting paid down automatically just like your main mortgage.
I’ve been re-reading this article countless of times as I’m about to embark on the debt recycling train but I’m not sure which investments to put the money into? I’ve read that most likely Peter Thornhill uses ARG and AFIC but the yield is very low, it doesn’t leave much headroom if/when interest rates go up. Would VDHG be a good choice? It doesn’t always provide franking credits, would that make a big difference?
Alex, I wouldn’t choose investments based on their yield alone. If you are doing debt recycling properly, it means you were planning to invest that money anyway… which also means you are going to be paying the interest anyway (this is your existing mortgage remember). So in this way it doesn’t matter whether your investments are high yield or low yield.
You’re more or less just passing the money through your loan first. This is a different discussion than borrowing extra to invest in shares where you may be concerned about meeting the higher debt repayments. You should really choose the investments you want, and not worry about trying to juice the yield or optimise for tax.
Heya Dave,
Was wondering what the setup would look like at the end once you’ve reached the max borrowing power and you’ve paid off your mortgage? Say your $600k home is paid off and now you have a $600k portfolio / loan, will the bank let you keep servicing that loan as long as you like? Or how can things play out?
Ta,
Love your work!
Well it depends how you’ve structured it. If the loans are all P&I, then your loan balance will continue to go down over time till it’s gone. If you keep requesting interest only loans, you can keep that debt there forever, or even increase it over time if your property value has increased and you want to really max out your borrowing to invest more (since on a $600k home, you’re usually borrowing up to 80%, which or $480k. There are a lot of options, but it all depends on whether you want to be debt free or not, and whether you can prove your serviceability to the banks.
At some point, people usually decide to just let the loan be paid off completely since the debt recycling strategy has run its course. Or they’ve simply had enough of using debt and want to simplify their finances/reduce risk by going debt-free. Hope this is helpful.
Great article Dave here. We have a good mix of Real estate (Few IPs on Int only loans and PPOR paid off) and Stock asset classes (via ETF) over the last 5-10 yrs and continue to skew onto ETF side. Did you or anyone had experience on Interest in advance Tax deductible (fixed) loans leveraging PPOR for investment into Stocks/ETFs? The rates are pretty aggressive compare to any products out there but you need to pre-pay a year of loan in advance..
Cheers Abby. I haven’t personally done that before, but I can see how it could make sense to get the cheaper interest rate. If someone has the cash available it could be a good idea, but it’s an individual choice at the end of the day.
Thanks Dave for a sense-check on my post. Very much appreciate.Think key here is cash flow as you said and it’s leverage to maximise return differential as part of debt recycling gameplan.
Incredibly useful article and comments! Just wanted to thank everyone for that.
One bit that I completely did not understand was “Monthly debt recycling” section in the actual article.
Here it is below again. Could you please explain it simpler? I feel it’s a very important advice but somehow I did’t get what would need to be done.
Many Thanks
Monthly debt recycling
With this method, you use some equity in your home to create a separate loan split. You pull this equity out and put it into a new offset account which you attach to your new loan split.
As you save each month, instead of investing, you pay down your main home loan. You then pull the same amount out of your new offset account attached to your new loan.
The interest on the new loan is tax deductible because you’ve used that money for investing. This lets you dollar cost average into shares rather than investing big lumps, which is more enjoyable and less stressful.
Thanks very much Dave for this great article.
I’m wondering if my assumptions is correct that the split loan for the share portfolio need to have a redraw facility?
Curious if you or any other reader on this blog have any recent experience with Suncorp.
Looks like that only have redraw facility on variable loans and splitting a variable home loan into 2 x variable loans isn’t common.
Good question. My understanding is yes you need the ability to redraw the funds at the beginning (which is usually no prob for variable loans), or at least be able to transfer the funds out to your investing account from the loan account.
Haven’t had any experience with Suncorp personally. Are they saying they can’t split the loan? It’s true that it’s not common because most people simply pay down their home loan and that’s it. If they refuse to do it you could consider switching lenders if possible.
Thanks for your reply.
They haven’t said “no” to my request. According to them, having a variable and fixed loan is more beneficial since we can get the best of both worlds.
They were trying to figure out why do I intend to split my loan to be 2 x variable loans.
I told them my accountant advised me to do so.
Still waiting for their response 😐
Haha yeah, well they’re a bank who just deals with plain vanilla customers so they don’t typically appreciate anything outside the norm 😉
Sometimes it’s painful being on the phone when you seem to know more about loans than the customer service person does. Not to be unkind, but it’s common for them not to be all that switched on with the different options. Had an issue just a week ago the person was getting confused with all the different rates that was on offer for different LVRs, fixed periods, and purposes.
Finally managed to get the split application approved after back n forth emails.
Now execution time.
I’m wondering if debt recycling can be combined with investing via family trust. I might need to run this past my accountant.
Do you have any experience/ idea about this?
Great to hear you’re ready to go, but I’ve got no idea on that aspect, sorry. Couldn’t hurt to run the idea past your accountant I guess.
Hi Dave,
Great article about debt recycling and great website overall!
With a regular debt recycling plan with amounts of 20k, will you run into an issue with hitting the max number of splits the bank will allow on your home loan?
Also do you end up with a separate offset account for each variable loan split?
Hey thanks, that’s pleasing to hear! Yes, that’s definitely possible to run into a limit on the number of splits. I have seen mentions of 10 being a limit, and some lenders are more flexible than others. On offsets, to my knowledge there’s no need for a separate offset for each facility, provided the one offset you do setup is kept ‘pure’ – only used for parking loan proceeds in and drawing from to invest with.
hi Dave,
I’m trying to get my head around using 1 pure offset with multiple split facilities. Won’t this make the interest portions on each split facilities a mess? How does the facilites even know which portion of the money it is suppose to offset?
Thanks,
Hi Donald. Because each loan split is separate, it comes with its own interest summary each year, making it very simple at tax time. If there are multiple, they simply need to be added up. And for an offset account, you link this to one of your splits, it doesn’t matter which one as they are each tax deductible. Hope that makes sense.
Hi Dave, thanks.
So in the case of having no offset facility, the redraw can go to a pure transaction account before going to the broker. By pure I mean a dedicated account just for this use…not to be mixed with daily non-investment transctions. Correct?
Hi Dave,
thanks for sharing the idea of Debt recycling and definitely help in our situation now. I am in the middle of getting it set up after reading your post and I just have one question here. Would it be easier if we can have a split loan eg: 200k main home loan , 100k variable loan with free redraw for debt recycling and we will pay it all with cash with a balance of $1 ( so it doesn’t closed off) and then we can pull out a smaller amount whenever we wanted to invest into share? and the interest generate on the loan it self is tax- deductible? I am a little confuse when Offset account comes into play. Does it mean we have a home loan balance of 100k, offset account balance of 100k , then we can claim the interest generated whenever we pull from offset account? as we are not planning to invest 100k as a lump sum. Sorry for the long comment Dave, hope you can guide me a little here.
Thanks and your help is much appreciated.
Hey Ruey. I’m not an expert on all the scenarios, but how you’ve described it makes sense to me. The offset is simply so you can put the ‘borrowed’ funds in there and not mix it with your own money. Also, often you’re not allowed to transfer directly from a home loan to a brokerage account for investing, so it has to go somewhere else first, like an offset account. This is why it has to be a separate offset account, attached to loan you’re using for debt recycling, which isn’t used for anything else. You can pull the 100k out, put it in this offset, and the loan will not charge any interest until you invest money from this offset account (since it is offset). But if the lender lets you transfer funds out from the loan, there’s no need for this extra offset account. Hope that makes sense.
Hi Dave,
Thanks for the reply. What you said make sense. Once again, thanks for your time in replying to my question! You have been very helpful!
Hi Dave,
We have paid off our home.
Do you know if there is a way of getting a line of credit at roughly home loan rates and just supercharging our monthly share buying? If the line of credit was 100% for investment (eg in VAS) the interest it would be tax deductible and repayments could be made from dividends, franking credits and tax return? Is that right?
Nice work Geoff! Yes, you’re right in how you’re thinking about it, but a line of credit would be more expensive than a standard home loan (rate will depend on the lender). So if wanting to do it this way, follow the ‘monthly’ method outlined and create a separate loan which you draw from each month and send to your brokerage account along with your other savings. Hope that helps.
Hi Dave
Agree with others that this is a super useful guide to what can be a complicated thing to get ones head around. Also thanks for your podcast – I’m a committed listener 😉
I have essentially already paid off my
home loan (I have reduced repayments to $1 a month to keep the loan active incase I want to redraw.)
As a debt recycling strategy, if I decide to redraw say $100,000 to invest in shares, do I still need to split the loan as you describe here? Given the non-deductible component of the loan would be essentially paid off already in full, perhaps there is no need to split the loan anymore as all interest would be deductible?
Grateful your advice and hope you have an enjoyable holiday period (although I guess you are permanently on holiday these days!)
Hey Dave, thanks for the feedback and listening to the pod!
If a home loan effectively has a zero balance, then I personally wouldn’t bother splitting the loan. But you could always ring the bank and make sure they will keep the loan open if you do pay the balance down to zero officially. I did this with AMP years ago and it only took a couple minutes to confirm they’d leave it open. My guess is most banks would leave it open by default and we’d have to ring to close it down (but not totally sure) 🙂
Dave! Thanks for writing this up, it’s been good to see it explained in plain English.
One thing I thought wasn’t addressed in the post though, was the strategy to then pay off the loan you’ve just created?
Using your example – we’ve just split out a 100K loan, paid it down to $1, and then we start using the monthly investment strategy (so we can DCA into the market).
What is the best way to pay off the 100K debt/loan you’ve just created? You’re likely not going to be able to make the repayments with dividends (unless you have a sizeable portfolio), so really this needs to be serviced by your income, right?
I’m thinking this should be a consideration also if wanting to take out this strategy. Make sure you’ve got the income to service the loan, and also probably make sure it doesn’t clash or coincide with other plans of yours (e.g. if you wanted to buy another property and this threw you out of the game due to serviceability).
And the other thing I thought of – do you want to ideally be beating the interest rate on your loan with your investments? I.e. you’re loan is at 3% IR, ideally your investments should return >3% p.a to make this strategy viable, or does it not really matter since you’re taking care of the loan repayments via income, and you’d expect the market to do well over time, rather than immediately (if you started the execution of this strategy during a recession for example, you may not be able to beat the loan interest rate for a good while).
Thanks again mate 🙂
Hey Rocco, glad you enjoyed the article 🙂
Firstly, the new loan that has been created is simply a broken off chunk of the old loan. A $400k loan turns into a $300k loan and a $100k loan. Usually people will focus on paying down the $300k loan first since that’s their owner occupied non-deductible home loan. You simply continue to make your repayments just like before, since those repayments remain the same as your overall debt has not increased.
If you’ve increased your debt to do this, you’re not really debt recycling, but borrowing to invest, which has different trade-offs. They sound the same, but they’re not. I wrote about that here.
With returns, of course you want a good long term return. But you don’t necessarily need the income to cover the repayments, since you were already making your home loan repayments before. So as long as you’re investing sensibly into long term investments, it should be a greater return over time than the mortgage rate.
And yes, it’s always better if you have surplus cashflow since it makes your financial position more secure, and having regular ongoing savings will speed up this process 🙂
Great info! Thanks for making this clear.
One question I have is how this works in a married/de-facto relationship where both parties are on the mortgage.
Can a split be made that is relevant for only one person’s tax reporting/investing? How are shared mortgages factored in for debt recycling?
Hey Will, happy you liked the article. My understanding is that for tax purposes, the claimable interest goes to whoever owns the investment that was purchased with the debt. That’s the over-riding factor. Even if there’s two people on the mortgage. Otherwise, you can always check with an accountant about a certain situation and get their take on it.
Really interesting article Dave, and great to see you are still getting traffic and responding to questions.
My situation is different.
I have 2 properties w/P&I HML.
i. Property A is an investment property generates a positive income Val aprox $1.5 with a $200k loan & was our old primary place of residence.
ii. Property B is our new primary place of residence & is also P&I with $600k loan against $1M Val.
I want to minimise tax & move Loan B ($600k) over to Loan A utilising the equity to pay off Prop B. The bank has confirmed this can be done via HML Porting, that is porting the security and associated debts etc.
Q.
1. My accountant thinks this strategy is debt recyling…is it?
2. Regardless, will the above strategy legally achieve what I need (pay day non deductible loan B & provide a tax benefit via property A)?
3. or is there a better strategy?
TIA
Hi Greg, thanks! Interesting question. While I’m not a tax expert, I do understand a little around deductibility of certain things. Here’s what I’ll say…
While you can technically move the money from A to B and have a debt-free home, making Prop A’s debt much larger once again, the interest on this loan WILL NOT be deductible. Why? Simple. Because the original loan for Prop B was used for personal purposes (to buy your own house). This original purpose (and therefore deductibility) hasn’t changed by moving the loan elsewhere. Interest is only deductible if the money has been used for income producing investments… doesn’t matter if the debt is attached to your home or IP.
So while you end up with a debt free home, your accountant is wrong, it’s not debt recycling, and it’s not deductible. Unless of course there is some other arrangement or maneuver I’m not aware of. You’ll still have the loan to pay and the same amount of income to do it, the facility has just been moved that’s all.
One way to achieve something similar is to sell Prop A (depending on how long it’s been a rental for, it may not have much taxable gain), pay off Prop B, then buy a new investment with the remainder of the money and borrowing against Prop B. Granted there are costs and perhaps tax involved so it’s definitely not something to go into without doing the numbers. But that is one way to do it. There are probably more efficient ways to structure it, but it would require more in-depth discussion and planning. If you’re interested in that, you may want to reach out to a structuring expert like TerryW – I haven’t used him, but have seen enough online content from him to know he knows what he’s talking about.
Hi Dave,
Quick question!
Why do you need to create multiple split loans while debt recycling?
Can’t you just repay and redraw 10K multiple times from a split loan of say 100k?
What is wrong with doing this?
Thanks in advance
Hey Dan. You can do it that way, but if you do 10k multiple times, you’re effectively paying down the same 10k each time and pulling it back out. Balance goes from 100k down to 90k as you pay it down, then back up to 100k after you redraw and invest. Tax deductible interest is 10k. If you do this again with a further 10k, you’re paying it down to 90k again, and then redraw and invest, bringing it back to 100k.
For practical and tax purposes, this looks like the same 10k of debt being paid down and redrawn each time. That’s why it’s best to do it in separate chunks or in a lump. Doing it this way, there is no way to demonstrate that the tax deductible portion is increasing. Hard to explain but hope that makes sense. And this is with my non-expert level knowledge 😁
Hi Dave,
Thank you so much for your prompt response.
You nailed it with the comment “there is no way to demonstrate that the tax deductible potion is increasing”.
Yes, an investor can choose to make extra repayments to their investment loan. But doing so will actually reduce the amount of interest payable on the loan and this in turn will reduce the amount of interest that can be claimed as a tax deduction.
This is because banks only calculates interest owing on the remaining balance of the loan.
Making extra deposits made into the loan actually reduce the amount of interest payable and hence the amount of interest that is deductible.
Therefore, maximum interest is payable and deductible only once the loan has been drawn down to zero.
It is therefore essential to get a new split loan each time and investor has spare cash to invest so that each split loan too can be drawn down to zero to get the benefit of the maximum interest deduction.
I hope this makes sense! Please feel free to correct me if I am wrong so that other readers can also benefit!
Warm regards,
Dan
I believe you can actually use your spare 100k equity (if you have some spare). Each month you could pay what you were going to invest into your home loan then take the same amount out from investment loan. You could do this monthly and it will save you doing 10x 10k splits for example.
Say you have 100k and you invest 5k a month. Your investment loan would go 100k,95k,90k etc. Your redraw would go up. The key is not to move money back into the investment loan. once you have done that 100k create another separate split with the extra money you paid into home loan/redraw. rinse and repeat.
Is there any way to debt recycle existing shares that weren’t purchased with debt recycling?
Say I have $100k in shares and buy a PPOR, is there anyway to debt recycle that $100k other than selling the shares (and paying any CGT) and rebuying after putting it through the mortgage?
Good question. Not that I know of. It can only become investment debt once it’s been paid out and then redrawn, so you’d have to sell to recycle. And probably unwise to sell and re-buy the same shares or it looks like the only possible reason you did it was for a tax deduction, which the ATO tends to frown on, and from my understanding, they can reject any deduction based on that alone.
Hi Dave,
Great article and I really like it. Do you think it is still a good time for debt recycle at today’s environment? Interest rate for home loans are more than 5% (P&I). Do you think the dividend return on LICs can still cover the rising interest rate or other associated costs?
Cheers Ben. Well, would you still rather invest or pay down debt? It’s a very personal question. Because debt recycling is just a tax efficient way to invest (it’s not increasing borrowing, just to be clear).
I personally still prefer to invest than pay down debt. I still think we’ll receive a higher return from shares than paying down a mortgage rate even at 5% (the difference at this level is probably not large). But for other people, different factors may be more important. For what it’s worth, Aussie shares are still yielding around the level of mortgage rates. But things can change, so I wouldn’t base it on that alone.
Sorry Dave disregard the first comment it’s a nightmare to read
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Awesome article Dave. Been looking into debt recycling for a while. Two questions I have that I don’t quite understand:
1. Debt recycling in chunks using money you already have
Using your numbers in the example, you have a 500k property with a 300k mortgage and 100k in an offset account. You split the loan into 2 accounts of 200k and 100k. You pay off the 100k account with the offset money and then redraw it to invest. You then use the extra income from dividends and tax savings to direct into the 200k loan to pay that down as it’s the non- deductible loan. I get all of that. However, what happens to the 100k loan? is it forever tax deductible now or does it reset every tax year? if it resets, then don’t you need another 100k to repeat the process? I’m unsure how you would pay this portion off. The only realistic way for most people is like you said, pay in small chunks of 10-20k. But even then saving 10-20k within the tax year will be a challenge especially in current circumstances. So would you say it’s only realistic for people who can save that 10-20k each year or am I missing an easier option?
2. Monthly debt recycling
Using the same figures, for a 500k property with a 300k mortgage, let’s say you want to bring borrowing back up to 70% LVR so you use some equity to borrow 50k and stick that in separate offset account. Say you save $1,000 a month and put that into your main home loan. You then match that by pulling out $1,000 from your new offset account which you then invest with. I get all of that. By doing this strategy though, wouldn’t it be a nightmare to calculate the deductible interest portion on each $1,000 you pull out and invest, as you are not taking the whole 50k out immediately all at once? I’m struggling to understand this part.
Thanks Brendan. It’s certainly not the easiest topic to understand, and definitely not essential to getting ahead financially. I even confuse myself about it sometimes, haha.
1. The $100k loan is permanently tax deductible as long as you hold the investments that were purchased with this money. Just like a property loan remains deductible as long as you own the property.
2. If someone is unable to save more than $10k per year, I would tell them to focus on earning/saving more than worrying about debt recycling. We only have limited time/energy, so it needs to be spent on the highest payoffs. Debt recycling is notoriously confusing for people to understand, and they could easily end up much better off using that time/energy to increase their income or optimise their spending.
3. It shouldn’t be a nightmare to calculate. Because the 50k is offsetting the new 50k split, the interest payable is zero at first, and will only accrue as the 50k is drawn on, so the monthly interest should be visible from looking at the home loan account each month/year. The key again is to keep the new 50k loan separate from the original 300k.
Hope that makes sense. And again, this is with my non-expert level understanding 🙂
Thanks for your reply Dave.
Yes I see that makes sense. So basically all of the interest accrued over the year on the 50k loan is deductible?
I agree with directing energy to increasing income. I just also hate paying more tax than I have to haha. If I have 50k in an offset already, would you say it’s best to put the whole amount into a separate account and then DCA into shares by investing 5 lots of 10k for example? or just put 10k into a separate account and then invest that, and then put another 10k into the account, and then repeat 3 more times until the total 50k is used? Is there any difference in interest calculation? forgive my amateur understanding of interest calculation.
If it’s setup as described, then yes.
On your 50k proposal, I can’t advise you what to do and this is where I can get into trouble (see my articles on ASIC earlier in 2022 for more on this). But the interest calculation won’t really make much difference between the two scenarios if I’m understanding your idea correctly. All the best 🙂
No worries, thanks Dave.
Hi Dave,
Thanks for the in depth article. Love your content.
I’ve already created a new split with my AMP Master Limit loan and am ready to start my debt recycling journey.
Hoping you can help with the following 2 questions:
1. Are there any concerns when transferring the funds from my new split (for debt recycling) to my existing online brokerage account if there are funds in that brokerage account? Or should the online brokerage account always have a zero balance? The funds aren’t contaminated at the source but would it be a concern if it mixed with existing funds in the brokerage account?
2. I have already purchased ETF’s through my online broker. Now with debt recycling I plan to add to my position in the same ETF’s. How would you treat the ETF base costs? Do I need to maintain a separate cost base for those ETF’s purchased pre debt recycling vs those purchased via debt recycling?
Thanks,
Chet
Hey Chet 🙂
1- As long as these funds get invested, then there isn’t really a problem at all. It’s not like it’s mixing with your personal spending account or anything like that. If you wanted to try and make it ‘cleaner’ you could transfer say $5k, and then make a $5k purchase once it’s cleared. This would leave a very clean trail in the event you are ever audited. But as long as that money ends up getting invested from the brokerage account, that’s the main thing.
2- Unless there’s something I’m not aware of, there’s no need to do anything different with tracking for capital gain purposes. The fact that it’s borrowed money doesn’t matter. The overall capital gain position is merely determined by purchase price, cost base adjustments and selling price.
Hope that helps, and I could be wrong of course since I’m not a tax expert, so if you wanted some extra comfort you could always ask an accountant.
Thanks Dave, appreciate the speedy and detailed response.
Hi Dave, appreciate this well-written explanation, really dialled it down to readable chunks!
I have a question re: interest rates, how does it influence your decision to recycle?
If interest rates are high, would this make recycling less attractive? Or should we disregard this and approach this from a long-term perspective that overall the markets will beat this?
Thanks x100
Hi Dave, glad you enjoyed the post.
Well interest rates do affect this decision in a roundabout way. First, decide whether you’d rather invest or pay down debt with your surplus savings (that’s the main decider). If ‘invest’ is preferred, then it only makes sense to re-route the money through a mortgage first to convert that debt into tax deductible debt, if one doesn’t mind a bit of extra effort/complexity. This would have the effect of improving the after-tax returns of that money which gets invested. But if paying down debt is deemed more attractive, for either personal or financial reasons, then that’s perfectly good too.
Hope that makes sense.
Got it! Thanks for the fast reply!
Hello Dave! Awesome post and it’s hard to find good information on this topic. Question I have is:
My mortgage is $340,000 currently with equity around 1.4 million ish. I am 51 and we bought at the right time in the right place (for us!) So, I re-finance and get a loan for what? 200K> I then buy some shares, diversifying of course, then I have to wait a year for the dividend payment plus also pay off the loan, which on 200k at 6% is $1000 a month. Then i get paid say 5% of 200k which is 10k so I whack this off the mortgage, then I can use that 10k to buy more shares, is this loan a line of credit type of loan? I still need to service the loan, which has now gone up to 210K? At the end, I end up with no mortgage and a huge loan, do I sell the shares to pay that off or use dividends or a bit of income/dividends? Sorry if this question sounds dumb, I kind-of get it but the bit in the middle confuses me lol
Hey Geoff. I think you’re confusing taking on additional debt to invest with and debt recycling.
Debt recycling in practice for a situation like you describe would roughly work like this: set up a new loan for 100k, just variable IO or P&I, but don’t touch it. Use your ongoing surplus cashflow to pay down the current 340k. Say you do this by 10k at a time, every few months or so. Then pull 10k out of the new loan to invest with. Use all spare cash including dividends to pay down the 340k, then taking the same amount from the new loan to invest with.
Overall debt is the same as if you were just making normal repayments and investing separately, so you are not increasing your overall debt load and in fact debt will still slowly reduce over time due to repayments. But now you have a small piece that is tax deductible.
Hi Dave
I understand how debt recycling works when you have non deductible debt…
But can you help me better understand the benefits in the following circumstance;
an individual has a $500,000 loan on the PPOR with $500,000 in its offset on I/O terms effectively paying $0 interest.
If this individual was to put the cash in a redraw facility then purchase $500,000 worth of shares yes this would be deductible but this individual would also then have $500,000 debt against these shares.
As opposed to …
An individual that leaves the situation as is, paying $0 interest on their PPOR loan and then moving forward by dollar cost averaging into shares monthly with cashflow, no stress no risk no debt, slowly building their ETF portfolio.
I don’t understand all the rage of debt recycling for individuals who are “fully offset” with non deductible debt to begin with.
Hoping you can share your wisdom.
Hey Luke.
Well that’s a pretty rare situation, where there’s essentially no home loan debt to begin with. The main reason someone would debt recycle is if they wanted to invest but also have non deductible debt they’re paying down. Debt recycling is never promoted as something for people in your situation with essentially a paid off home.
The main tax benefits moving forward would be to do a variation of what you’ve described (pay off then pull out). But you could pay down the loan and invest in chunks rather than all at once if that’s what you prefer, while reducing the offset cash to match your remaining PPOR loan. You’d have to get the loan split as described in the article and make sure the offset was linked to the PPOR loan split. There may be other methods too which savvier people may be able to point out.
All that said, if someone likes the simplicity of that setup (and it is pretty damn good), then just ignore all the fancier strategies and build the portfolio as planned – it’s an excellent approach.
Question for you, if that’s what you’re doing: do you plan on getting rid of the home loan, or continuing to refi to fresh IO loans to keep the facility open and the current setup going?
Thanks for your prompt and detailed response Dave, we appreciate it.
We do love simplicity, hence our current situation. However can’t help but query whether the benefits of debt recycling (as per your variation method above) out-way the simpler approach, whilst keeping in mind the increase risks of leveraging.
We find comfort in having such a large amount of savings however mindful that it’s not actively working for us.
In regards to your question, this is exactly why we are weighing up our options, as our current PPOR loans IO period is up for expiry. With this it has created a moment in time to re assess. We are contemplating next steps regarding whether to go P&I or IO.
You probably already know this but your savings ‘are’ working for you… it just might not technically be quite as hard as they could be. But that money is still earning/saving you a decent amount. Same as a paid off house saves you rental payments.
If you love simplicity, I would let that be the guiding force in your decisions. Many people, myself included, tend to overcomplicate things and then realise how awesome simplicity was to begin with. There’s more to life than squeezing out a little more financial gain 🙂
Great article Dave, love you work and insights
How do you feel now in Jan 2024
About debt recycling given that standard variable interest rates have cruised past the 7% mark,
A lot more people would probably prefer to pay down debt in the current environment
Hey Mick. Good question. I actually wrote about this not long ago here: https://strongmoneyaustralia.com/mortgage-vs-investing-vs-debt-recycling-at-higher-interest-rates/
Debt recycling is actually more attractive at higher interest rates than before, just like paying down debt is. But a lot of people will find it more appealing to just pay down debt since it’s the simpler option.
Hey guys great article,
Just curious would a high dividend share (such as VAS) be a more appropriate investment than a blend of growth/dividends (such as VDHG) when it comes to a Debt Recycling strategy?
Incredible article (and book!). We have a split investment loan and an associated offset account. Invested through it a year or so back. Question: If we now park some spare money in the associated offset account simply to offset interest, does this contaminate the loan? Or does contamination only occur when money goes into the loan account? Thanks in advance🙂
Thanks Milo 🙂
Is the offset account currently empty? If so, then it should be fine. But if you also have funds from redraw/loan split sitting in there yet to be used, then adding outside money may contaminate it, especially if you take it back out again. The easiest solution though is to simply make sure that the only time money ever leaves that offset is when it gets invested. Hope that makes sense.
Good day,
In the example anove, how would debt recycling compare to am Option C:
Pay down $100k of debt (your non-deductible home loan). Pay $4k less interest
I can clearly see the benefit compared to a straight investment, but not so sure against less interest?
Secondly, would an investment property be another form of debt recycling?
Well that opens a different discussion. You’re now comparing paying down debt vs investing. I wrote about all three options in this post: https://strongmoneyaustralia.com/mortgage-vs-investing-vs-debt-recycling-at-higher-interest-rates/
Investment property is different. Since the debt is already tax deductible, there’s no benefit to debt recycling. So the question then becomes investing that money in something else or paying down the debt like above.
Hope that helps.