Imagine you just bought yourself a home to live in for the foreseeable future.
It’s in the spot you want, and you can turn this house into a really liveable and comfortable headquarters for you and your family.
Better yet, let’s imagine you were somehow able to buy this home with cash! No mortgage or debt of any kind. You didn’t kill anyone for it. You get to keep all your organs. And you don’t owe Fat Tony a questionable favour at some unexpected point in the future.
Just you and this debt-free home. Who in their right mind would alter such a sweet scenario?
Well, we did! And in this post I’ll explain why. What we’ve done is unusual, but it’s not as silly as it might seem at first.
Earlier this year, I discussed how we managed to buy a home despite not having proper jobs anymore. You can go back and read the full story here, but the short version of our plan was:
Step 1: Buy a house with cash, by selling shares and using our large cash buffer.
Step 2: Sell an investment property (IP) which we were going to do anyway.
Step 3: Upon settlement of IP, transfer the existing loan to the home we had just purchased with cash (this is called ‘security substitution’ or ‘porting a loan’).
Step 4: We receive the sales proceeds from the IP (after costs and some loan adjustments).
Step 5: Reinvest this lump sum back into shares, and top up our bank account.
Step 6: Continue monthly investing into shares and slowly selling down our IPs as per our plan.
Thankfully, we’re now on the other side after moving through all the steps! So I’m now fleshing out some of the details on what this means for our situation and why we’re doing this versus sticking with a debt-free home.
As you might guess, we could have stopped at Step 1 and kept a paid-off home. Then, with the proceeds of our IP sale, invest this money into shares, top up our cash, etc.
So why did we bother with the rest of these steps? Two big reasons.
Reason 1: By keeping the loan facility open, and transferring it across to our home, we get to keep almost the entire proceeds from the sale of our investment property. That’s a shitload of money, to reinvest into shares and maintain access to and control over that we otherwise wouldn’t.
Reason 2: Before reinvesting this huge chunk of cash, we’re able to pay down the loan facility to zero, then pull the money back out to invest it. The outcome of that is the loan becomes tax-deductible because it was used for investment purposes.
Basically, we’re choosing to have a larger share portfolio and keep the debt, compared to the opposite. The idea being we will earn a higher long term return from our investments than the interest we pay. It’s the classic decision of whether you should pay off your mortgage or invest.
Obviously, with interest rates rising, that calculation has changed a bit. But shares are also cheaper which balances that out to some extent. It’s still my view that, on average and over time, the after-tax return from shares is likely to comfortably exceed mortgage interest rates.
Thanks for the push from structuring expert Terryw who commented on my original house-buying post that I should probably look at debt recycling in our scenario.
Without going into things, I was hesitant to do so because it would’ve been rather messy with our previous accounts. So, the best solution was to simplify our investing accounts by moving to a single joint account (to match our joint home loan). This meant offloading the rest of our shares, but thanks to the market downturn, there was no capital gains tax.
In practice though, this means we had a very large pile of cash to invest/reinvest after the above process. Funds from the property sale, plus our liquidated share accounts.
Regular readers will know I like to invest our cash steadily over time. So did we really invest such a big lump in one hit?
Well, yes, but not really. Due to our bank we were only able to transfer $50k per day, so it still took a few weeks. That’s a lot less scary than doing it all at once, but it’s still a speedy way to deploy cash!
To be honest, it wasn’t nerve-racking at all. And while that makes no sense on the surface, I think that’s due to two main reasons…
Lump sum investing stomach-calming reason #1: A lot of it was reinvesting money we had only just taken out. Our portfolio now is about 30% bigger than pre-house-purchase at the beginning of this year.
Lump sum investing stomach-calming reason #2: The market was down 10-20%, so we were investing and increasing our portfolio at much cheaper prices (and yes, I’m very grateful bout that!)
In addition to this, I’m also approaching our ongoing cashflow slightly differently to before.
Did I take the opportunity to change anything with my portfolio?
Actually, no. I basically replaced everything the way it was before, only bigger. But there is a different type of change that’s worth mentioning.
Regular readers might recall how our cash situation works. I detailed it in this article, but until now here’s how we’ve been operating:
Sell an investment property. Invest from this cash pile each month to grow our share portfolio, while covering other property expenses and our living costs depending on investment income and part-time work.
After a few years, sell the next IP and repeat the process, until we’re 100% invested in shares.
So what’s the change? Well, after this latest property sale and lump sum investment, we’ve moved to being fully invested.
Why? Well, our portfolio income and part-time is more than enough to cover our expenses, the remaining property outflows and have some cash leftover to invest each month.
Our part time income (mostly Mrs SMA, to be fair!), doesn’t seem to be disappearing, which is obviously very useful and hugely reduces the need for any sort of cash buffer as a backup.
If we decide to stop earning any sort of personal income whatsoever, we can just live off our investment income, and sell our remaining properties to get more cash while also removing a possible headache and risk.
Having less properties and more shares has reduced our outgoings and greatly improved our cashflow, which is fantastic and is the main reason behind this move. ‘
Our cash now is about 1% of our net worth, which feels good after it being elevated for so long. There are now three properties left, which we will probably offload in something like two-year intervals.
The outcome of all this is:
We have a beefed up share portfolio that roughly covers our personal expenses. We now have a tax-deductible home loan. And we’re almost fully-invested and have very little cash.
It took a bit of fluffing around to get here, and some help from our mortgage broker, but the end result has been worth it. Having said that, I’m sure we would’ve also been happy with a paid-off home and a smaller portfolio.
Well, I hope that all made sense! Let me know if you would like me to elaborate or clarify anything and I’ll do my best.
To be clear, our house is still being paid off over time. We could decide to pay if off early with future property sales. Or we may even increase the loan later to invest even more.
Both options are attractive, so we’ll see what’s happening at the time and which option feels like the right move. And that’s probably the greatest part of all… having options.
What are your own mortgage plans? Destroy it as fast as possible? Cruise along with regular repayments? Use leverage to invest further? Let me know in the comments.
Here are some resources you may find useful on your wealth building journey:
Sharesight: A great portfolio tracking tool for share investors, and free for up to 10 holdings. It tracks all dividends, franking credits and capital gains, which is incredibly helpful at tax time. Saves me a lot of time and headache!
Mortgage broker: My personal broker of 10 years is More Than Mortgages. Highly rated and award winning, Deanna and her team been super helpful over the years and can assist with anything home loan related, including refinancing and debt recycling.
My book: After 5 years and hundreds of articles and podcasts, I decided to distill everything down into an easy to follow book. Designed as a complete roadmap to achieving financial independence and retiring early in Australia. Available in paperback, ebook, and audio.
Just so you know, if you choose to use these resources, this blog may receive a financial benefit at no extra cost to you. Thanks in advance if you do. And to be clear, I only ever recommend things I use myself and genuinely believe in 🙂
My thoughts on a behavioural trap I see in the FI community, how to recognise it and how to fix it. Far more common than you might think, and it can prevent you from enjoying the wonderful wealth you’re building.
Lizzie changed her career, moved location, sold her home and switched investment strategy. Now she’s looking to semi-retire in her 30s.
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Thanks for the article! I own two units in Perth that I paid cash for, is it possible to detect recycle them I if I refinance and put the proceeds into shares?
Cheers, Brent
Hey Brent. Well, there is no debt to ‘recycle’, so the process is simply applying for a loan to use for investing in that case. And whether that’s feasible comes down to your personal income situation + whether the banks thinks you can comfortably service the loan amount you apply for. If you keep the debt modest and you have a decent income, I don’t see why that wouldn’t be doable.
You have plenty of cash coming in, so makes sense in your situation.
I have been paying extra off our mortgage and it should be paid off in full in next year and half. Having no mortgage payments means our savings rate will jump alot and also means we can earn less if we wanted.
With this current uncertainty around it feels good to only have a small mortgage and a plan to have paid off.
Wow congrats! That will be a fantastic situation to be in – a huge drop in expenses once that happens, which is extremely cool! Having a paid-off home is the perfect time to consider semi-FI or just winding things back a little 🙂
Only today I’ve discovered that one the home loan is reduced, it’s very difficult to increase it again (or at least, it is wIth NAB) So all my big plans of increasing my loan size and merely debt reducing have gone out the window. I agree, keep the loan big even if you’ve got a heap of cash in there paid off – you can still access that cash if needed
Ah yes, that can be an issue with reducing debt. Banks want to check all your details again even for a tiny increase. So there’s no redraw facility (or it’s restricted?) on your current home loan? If that’s the case, that sucks.
As you point out, keeping the loan + cash offers greater flexibility. And it’s why people often choose to park lots of cash in an offset account rather than pay down the loan, even though it has the same happy outcome of reducing interest payments.
Another interesting article Dave. I’m 48 and still have a $1mill mortgage. I have a good income but I’m so torn between investing and paying down the mortgage. I know I should pay down the mortgage but investing is way more fun particularly in a depressed market. I still haven’t got my head around the debt recycling and I’m not sure if it is appropriate at my stage of life?
Thanks Chris!
I would personally opt to attack the mortgage if I was in such a scenario. That’s because if it’s paid off by 60, then it dramatically reduces expenses at the same time as a super income stream becomes available and a pension is not all that far away (if no other investments are available).
It also depends what excites you the most, and by that I mean what will motivate you to save as much as possible (being debt-free, or having a portfolio of investments).
Why not do both? I was all for paying off our $700k mortgage in 7yrs with an extra $6k/m but found that by using the ING extra repayments calc, we’d be far better off paying $4k/m into the mortgage and $2k/m in ETF’s.
Only extends the mortgage by 2yrs
and pay an extra $40k in interest *but* by Year 9, we’d have paid off the house *and* own $250k+ of shares generating about $10k in distributions. By far the better outcome!
Hi Dave, another great post. I have been paying off our PPOR home loan and only have 3 years (or less) to go. I’m not as courageous as you 🙂 Happy to pay this mortgage off and then increase the share investing.
Looking forward to seeing what you do with the next IP’s and if you decide to pay off this mortgage.
Cheers Pete 🙂 Awesome job on the mortgage too, very nice! It will be a great feeling when that payment disappears.
Hi David,
An observation to add, which is too late for you but may be relevant for someone else in similar shoes who wants to transfer shares from individual accounts to joint accounts: instead of selling the shares, withdrawing the money, transfering it to the joint account and then re-buying, you could have just done an off-market share transfer. What it means is that you transfer the shares themselves (so not cash) directly from your individual account to the shared account, so you don’t spend any time “out of the market”. From a tax perspective you still have to pay CGT, and it takes 1-2 weeks for the paperwork to go through, but it’s much simpler (e.g. you don’t have to transfer it in 50k increments)
Ah yes, that’s a great suggestion, thanks for sharing! It’s outside of my realm of understanding, but I am aware of the possibility.
I don’t think that would’ve worked in our case, as we had to use that money to pay off a loan, and then redraw to reinvest. But well worth mentioning for the benefit of other readers, much appreciated.
Hey Dave, Interesting read.. In regards to changing anything in your portfolio you say you ‘replaced everything the way it was before’ – does this mean you went back to the LICs you had? Or are you still sticking with the simple VAS/VGS/REIT/QVE portfolio?
Hey Frank. Oh, I mean replaced it to exactly the way it has been in recent times, which is basically the portfolio you mention and what I shared in the latest portfolio update. 🙂
Hey mate, with mortgage interest of 5%, would you rather park your cash in offset account saving interest than debt recycling?
Hi Danito. I still prefer investing since debt recycling + investing is also very tax efficient, and I personally expect shares to return more than 5% pa long term. But simply paying off a mortgage or stacking it up in an offset account is still a very solid option 🙂
So what does your portfolio you’re using to debt recycle look like? Is it index funds or LIC’s?
Hey Rob. It’s mostly index funds, one LIC and some reits. You can see the portfolio in various updates on this blog if you type in ‘portfolio’ into the search bar and my latest update I shared over on the Pearler blog.
Hi Dave, great information and post. I am interested in your comment “By keeping the loan facility open, and transferring it across to our home, we get to keep almost the entire proceeds”.
Do you mean there are greater savings using security substitution? Is there any impact on CGT?
For me pay of mortgage vs invest, depends on the loan amount. If the loan repayments are similar to market rent, then keep the mortgage and invest. If the loan is more than comfortable then pay down. 😀
Glad you liked the post Mark!
There is no impact on CGT for the property sale, as that is determined by purchase price and sale price less costs.
The benefit is by keeping say $400k of loan facility open and attaching it to our new home (since it was debt free when we purchased), we then receive an extra $400k of proceeds from the sale of the IP, because otherwise the bank would normally take those funds to close off the loan and you get whatever is leftover. So there are no extra ‘savings’ as such, the upside is basically the returns you would get on the invested money vs paying off that debt. Which is why I compared the decision to the typical mortgage vs invest scenario.
Hope that makes sense!
Hey Dave,
Since you originally had an IP that interest would be tax deductible, I just want to confirm that you have now turned your principal place of residence into tax-deductible debt due to using the redraw for shares?
Hi Karen. Yes, that is exactly what I’ve done 🙂
Great post thanks Dave.
First time posting so sorry is you’ve covered this question previously…
We are within $50k of having paid off our $1.5m PPOR (maybe $80k of redraw available) and are looking to move in the near future.
We have a couple of IP’s but the largest loan is only $350k.
We would be happy to buy a new IP and use it for short term rentals (preferably something we could also use occasionally for holidays).
Could we do that and then use your transfer strategy?
Hey Scott, thanks for the comment.
You’re in an excellent position, so well done for that! In this situation, I’m not quite sure what purpose you see the loan transfer serving? What are you trying to do with it? In my case, it was to receive maximum sale proceeds from our IP sale so we could invest it. Are you selling an IP and hoping to transfer the debt to your current home so you can keep the proceeds?
Hi Dave,
Another good read!
I understand from your pay down mortgage or invest article in 2020 you were all for investing and not paying down debt and even now you are still sticking to this which I admire.
My question is if interest rates on home loans went beyond expectations and were sitting at 7-8% next year on home loans would your opinion change on your strategy or is the compounding to good to give up?
Thanks,
Damien
Hey Damien, thanks for reading 🙂
Excellent question. I think people forget that it wasn’t long ago that loan rates were 4% (in fact, when I first wrote that article I think mortgages were around that level). To be honest, I would probably start piling up cash if my offset could save me 7-8% in interest – that’s a very good tax free return. And then as rates came down again I would probably start investing it again.
Having said that, if the market was down 35% at the same time, then maybe I would continue investing as the returns from those lower levels could still beat the interest rate. So it depends on the context and what else is happening at the time. Hope that makes sense.
Yeah it’s alot to think about and I appreciate your thoughts. I’m fortunate enough to have a fully paid off PPOR at age 35 with my wife age 38. However over the past few months I have discovered borrowing to invest which could really boost me to fire! Will keep adding into our regular buying schedule. I think at the end if the year the picture may he alot clearer however markets could also rebound. It’s all an unknown! 🤷
That’s fantastic on the paid-off home – you’re in a super solid position whatever you end up choosing to do!
All these descriptions of debt recycling make my head spin, but let me see if I have a grip on it.
We are empty nesters and our plan is to do the following. Sell our large family home and take out a mortgage (non tax deducible) to buy a smaller home. With the proceeds of the sale of the large home we will pay off the loan (apart from a small amount), and then redraw from the loan to buy ETFs, thus making the loan tax deductible. Is this debt recycling?
Hi Alice. It does for me too, not exactly simple for most of us 😉
Basically, yes that is one way to do it. Keep in mind you generally need to buy the next smaller home before you sell the old one, otherwise when you sell the first one the loan will close off and you’ll simply receive whatever proceeds are leftover (you can’t keep the proceeds if the bank no longer has a property as security). If this would be a large chunk, then another option is to keep this cash, buy the next home using a loan, then pay down that loan with the cash before redrawing and investing.
Hi Dave,
I wrote a reply earlier but it seems to have disappeared. So I will try again.
We are empty nesters and plan to sell our large home and buy a smaller one. We are thinking of taking out a mortgage on the new home (not tax deductible). Then, with the proceeds of the sale of the old home we will pay off the mortgage (apart from a small amount). Then we will redraw funds from the loan to invest in ETFs, thus making the loan tax deductible. Is this considered to be debt recycling?
Thanks.
Is this article (August on mortgages) podcast as well? I’m having difficulty finding your podcast to search for it.
Regards Louise
Hi Louise, there’s no podcast version of this particular content, it’s just a standalone article.
Hi Dave, my partner and I decided to pay our home of around 6 months ago after the sale of our IP, but did think about debt recycling like you did. It came down to the simple fact that a fully paid of house was a mental thing and makes us sleep well at night. We also had by this stage started to build up a healthy share portfolio which was close to our FI number of $800k. We have both just decided to finish work early next year, even though we haven’t yet reached our FI portfolio target as we have had enough of the 9-5 corporate BS. The house is paid, enough passive income covering our basic expenses and an emergency fund. For now this is enough. I’m excited for what 2023 will bring,
That’s so fantastic to hear Matt, well done and huge congratulations!!
All the best with your next adventure 👍
Hi Dave, I’m not sure if anyone has asked this question, but can you explain this further?
“Reason 1: By keeping the loan facility open, and transferring it across to our home, we get to keep almost the entire proceeds from the sale of our investment property. That’s a shitload of money, to reinvest into shares and maintain access to and control over that we otherwise wouldn’t.”
Does that mean you didn’t have to pay CGT on the sale of the IP? How does that work?
Hi Sarah. No, the tax of the property sale is the same as before, that’s not changed at all by doing this. It’s just that we keep access to the money, because the loan is transferred from one property to another, and we get to keep the sale proceeds. Often when a property is sold, the loan automatically gets discharged (balance paid to zero), and then you’re left with whatever is left. Hope that makes sense.
Hi Dave,
I’ve only just discovered debt recycling, haven’t started doing it yet though.
I have/had future plans of downsizing or reverse mortgaging my PPOR.
It got me thinking that rather than paying my mortgage and increasing my equity only to try to reduce it in future…… why not just pay interest only 🤷♂️
I’ve got 23 years left on my mortgage and have no intention of working anywhere near that long so it will probably only get paid out on sale or death.
Is this a completely crazy idea?
Hey Anthony.
I actually love the idea of paying interest only forever. Debt has never bothered me.
But the problem is these days the interest rates for IO loans are typically a fair bit higher, which dilutes a good chunk of the benefit. Plus the IO period of 5 years runs out, and then repayments are much higher. You can of course refinance to a fresh IO period, but in retirement (as we are now) that’s not possible so you end up with pretty huge repayments you can’t get around unless your borrowing power is sufficient to refinance to a fresh 30 year loan term.
A great way to reduce the repayments to focus more on investing would be to refinance to a fresh 30 year loan term now rather than going to IO. It’s a very cool way of improving cashflow while keeping the benefits of a P&I loan.
Hope that helps.
Hi Dave,
I recently stumbled across your book and content, thanks for staring your story, it’s very inspiring.
We are in a vey similar situation as this blog, we have always invested in property and looking at better options.
We are at a real cross road as one of the IP’s has just increased in value for profits to cover paying off PPR (accounting for closing costs and CGT).
We are in our early 40’s and have a goal to retire in about 10 years, once the kids have grown up.
I’m trying to financially project the scenarios of; Sell IP paying the PPR off in full now (approx. $450k) and throwing extra monthly cash into ETF’s, Holding the property for another 10 years (its +geared) or debt recycle and invest a lump sum in ETF as you mentioned above with the taxable benefits.
What would be the best strategy to accumulate the most for this time frame (Understanding there are many variables)?
Also, can you recommend any tools to assist with projecting these scenarios?
Hey Brett, welcome, and thanks!
Congrats on the IP gains. In truth, there’s no right or best approach, just a few solid options. The simplest option is to pay off your home then invest monthly. Potentially the most lucrative is keeping the IP for another 10 years and also debt recycling your home. But what if the IP performs poorly from here, how would you feel about that? It all depends on the unknowable growth rate going forward.
Worth thinking about how the situation may go against you and which method could bring the most regret in addition to the upside scenarios. Ultimately either option is likely to get you close to retirement in 10 yrs depending on a few variables (savings rate, IP growth, share returns), so pick the one that fits best with your personality, your situation, and what you think is the highest probability outcome going forward.
Hi Dave,
great article as usual!!!
Just wondering do the ATO have any issues with selling down a fully owned portfolio, and then purchasing back the exact same share portfolio through debt recycling thus claiming the tax deduction
Hey Mick. It’s a good question. I think that could be worth asking the ATO on their community page, though they often give grey answers. It’s possible the ATO would frown upon that and disallow the interest deductibility, but it may depend on a couple of things. How immediate the rebuying is, how tax focused your actions seem, and whether there are any other factors involved.
Often they will disallow a tax benefit where someone has sold and then rebought to claim a capital loss to offset other gains (a wash sale they call it). In that case it’s obvious the only reason is a tax deduction. In the case of us in this article, there was a decent chunk of time between selling and re-buying (almost a year), we paid more tax by selling, we changed accounts from 2 single accounts to a joint account, and the main focus was not actually tax deductions but having a larger portfolio (debt recycling was more of a side decision of the whole process).
Thanks Dave for the quick reply,
No it’s not a wash sale,
Our daughter 23 has a portfolio with with blue chip,lic and etf ,
She is looking at getting a foothold in the property market in Perth (we’re in Sydney)
But she likes the idea of debt recycling and keep her portfolio growing while taking advantage of the tax system,
Maybe another option would be to sell down and put into a different etf eg sell a200 and buy vas??
If she’s going to be investing in property, then there’s no advantage to debt recycling. All her debt will already be tax deductible. But perhaps she already has an owner occupied home that you didn’t mention? In that case then there would be a way to convert some of that debt to investment debt if done correctly.