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The Ultimate Guide to Debt Recycling (2021 Updated and Revised)

July 20, 2021


Last updated: July 2021. 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!

 

What is debt recycling?

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.   Article coming soon – “Should You Borrow to Invest in Shares?” 

Debt recycling can be very effective, but there’s a few things to understand first and it’s crucial this strategy is implemented properly.

 

How does debt recycling work?

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…

debt recycling

(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.

 

A word of warning.

Sometimes debt recycling is spoken about like a magic 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. 

Saving remains the key to building wealth.  Debt recycling can be seen as tinkering around the edges.

Having said that, it is pretty cool!  Here’s a proper example with numbers…

 

How to do debt recycling, in practice.

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.

 

The numbers behind debt recycling.

Okay, here’s how it works using nice round numbers for simplicity using the steps above.  You have a $300k home loan with a 3% 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 $3k of interest as a tax deduction (interest on $100k).  You now pay tax on $1k of investment income, which is $500.

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 $1500 in tax that year compared to if you didn’t.

 

An important note about tax…

You can only claim interest expenses if the debt has been used to produce income.

Here’s the ATO’s statement regarding ‘dividend and share income expenses’:

“You can claim a deduction for interest charged on money borrowed to buy shares and other related investments that you derive assessable interest or dividend income from.”

“Only interest expenses incurred for an income-producing purpose are deductible.”

 

What’s the outcome of debt recycling?

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 your portfolio gets bigger and your home loan reduces compared to your investment loan.

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.

 

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 typically do it in chunks is because banks have a minimum loan split you are allowed to create, such as $20,000 for example.

But there is a way to debt recycle and invest in shares on a monthly basis.

 

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.

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.

 

What type of loan do I need?

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!

 

Is debt recycling legal?

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 paying more tax 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?).

If you’re not convinced you can always reach out to them with details of what you plan to do and see what they say.

 

Principal-and-interest or interest-only loans?

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 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 may 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.

 

Other tips.

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.

 

Final thoughts.

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.


Home loan help:  For assistance with anything loan related like setting up loan splits or getting a better rate, check out my personal mortgage broker More Than Mortgages.  I’ve worked with Deanna and her team for years and they’ve been fantastic.

Note: this blog may receive a small referral fee if you use MTM. I only ever recommend things I use myself and genuinely believe in. 

159 Comments

159 Replies to “The Ultimate Guide to Debt Recycling (2021 Updated and Revised)”

  1. 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.

    1. 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

      1. 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).

    2. 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.

  2. 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.

    1. 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 🙂

  3. 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.

    1. 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).

    2. 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!

  4. 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.

    1. 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 🙂

  5. 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.

  6. 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?

    1. 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.

      1. 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

        1. 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.

          1. 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.

          2. 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.

    2. 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).

  7. 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?

    1. 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 🙂

  8. 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!

    1. 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.

  9. 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.

    1. 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!

  10. 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.

  11. 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.

    1. 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.

    2. 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” ?

  12. 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.

    1. 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 🙂

    2. 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.

  13. 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!

    1. 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 🙂

    2. 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.

      1. 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.

  14. 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

    1. 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 🙂

  15. 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!!

    1. 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.

  16. 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

    1. Thanks for sharing that Frankie. There’s definitely something to be said for keeping it simple and not adding any unnecessary risk with leverage.

  17. 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.

    1. 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.

  18. 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.

    1. 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!

      1. 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

        1. 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!

          1. 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.

          2. All good Alex!

            Yep it’s certainly an unusual but attractive feature of those LICs, which may suit an investor depending on their situation.

      2. 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/

        1. 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.

  19. 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.

    1. 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?

      1. 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?

        1. 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.

          1. 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!

        1. 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.

    2. 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.

  20. 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!

  21. 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?

    1. Hey Ando, yes it does sound like you could have bought shares instead of putting it towards a property.

        1. 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.

  22. 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.

    1. 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.

  23. 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

    1. 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!

      1. 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

        1. 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!

    2. 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.

      1. 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?

        1. 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

    1. 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.

  24. 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?

    1. 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.

  25. 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?

    1. 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.

      1. That would be nice, but unfortunately a bit too good to be true 🙂

        Thanks for reading Tim.

  26. 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

    1. 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.

  27. 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?

    1. 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.

  28. 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.

    1. 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.

      1. 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.

        1. That’s good news Nick. Whatever investment you feel happy owning for the very long term – Vanguard index funds are certainly a good choice 🙂

  29. 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!

    1. 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.

  30. 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.

    1. 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.

      1. 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.

  31. 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

    1. 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.

  32. 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.

  33. 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?

    1. 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.’

    2. 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.

    3. 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

      1. 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.

  34. 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

      1. 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.

  35. 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!!

    1. 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

  36. 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?

    1. 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!

  37. 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

    1. 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.

  38. 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

    1. 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.

      1. Hi Dave,
        Thank you for your explanation. It does make sense now.
        Please keep the blog posting. Love it.
        Regards, choky

  39. 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!

    1. 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.

  40. 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.

    1. 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.

  41. 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

    1. 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.

  42. Pingback: Should You Own your Own Property? - The Frugal Expat
  43. 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

    1. 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.

  44. 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?

    1. 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.

  45. 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.

    1. 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.

      1. 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.

        1. 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.

        2. 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).

  46. 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?

    1. 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.

    2. 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.

  47. 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.

    1. 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!

  48. 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

  49. 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?

    1. 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.

    2. 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 🙂

      1. 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.

        1. 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!

  50. 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?

    1. 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.

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