When it comes to growing your wealth and securing a brighter financial future, it’s likely you’ve heard about the importance of turning bad debt into good debt. The strategy known as debt recycling, or mortgage recycling, is one way you can successfully do this.

But what exactly is the difference between good and bad debt and how can debt recycling help you turn one into the other?

At My Wealth Solutions, we define good debt as anything that is tax-deductible or is owing on a nest egg asset that can be utilised to help you grow your long term wealth. Bad debt, on the other hand, is any that is not tax-deductible and/or is not owing on an asset designed to help you grow your wealth.

Common examples of bad debt include car loans, credit card debt and even the mortgage on your principal place of residence. Yes that’s right, while owning a home can have a number of financial benefits, your mortgage may actually be considered bad debt.

But it doesn’t have to stay that way.

That’s where debt recycling can help.

Debt recycling, at its most basic form, involves using the equity in an asset you currently owe bad debt on to purchase an investment asset that can be used to generate an income. You would then use the income generated from that asset to pay off your non-tax-deductible loan until this loan has been paid off and you only have the tax-deductible loan to pay.

Sound complicated? Don’t worry, this comprehensive guide to debt recycling is here to walk you through everything you need to know about debt recycling and how it can help you achieve financial success and security.

This guide will explain:

• What Debt Recycling Is
• The Benefits of Debt Recycling
• The Downsides of Debt Recycling
• How Debt Recycling Can Help You

Or if you’d like to find out more about debt recycling in relation to your particular financial circumstances and needs, you can get in touch with an expert investment advisor now.

What Is Debt Recycling?

The short of it is that debt recycling is a way to turn your existing bad debt, such as the mortgage on your family home, into good debt that is both tax deductible and works hard to help you build a brighter financial future.

The long answer: debt recycling involves leveraging the equity in your non-tax-deductible asset, i.e. your mortgage, to invest in an income producing asset with the idea of then taking the income received from said asset to pay down your non-tax-deductible asset, in this case your mortgage.

Here’s a video from our licensee company, GPS Wealth, to help you understand what debt recycling looks like in action:

While it may seem like you are swapping one loan for another, debt recycling can have a number of benefits for those with a high income that may otherwise end up paying more in tax than they may need to.

However, debt recycling is not a strategy that is ideal for everyone. Since you will end up with two loans during the course of this process, both of which will likely be leveraged against your principal place of residence, you may not be comfortable with the level of risk associated with debt recycling.

While utillising a strategy like debt recycling can help you to amplify the benefits of investing and build your wealth in a quicker and more efficient away, it also amplifies the risks you may encounter in the face of a market turndown.

Determining whether debt recycling is the right strategy for you will depend on your risk tolerance, the time until you need to access your investment assets and your short, medium and long-term financial goals.

Your financial advisor can work with you to not only help you decide on your risk tolerance and financial goals but also whether debt recycling is the right fit for you and your unique financial circumstances both now and in the future.

The Benefits of Debt Recycling

Just like many financial strategies, debt recycling can have different benefits depending on your particular financial situation, income and future financial goals.

One of the most important benefits of debt recycling is that it allows you to start building your investment portfolio and growing your wealth faster than if you opted to follow a more traditional route.

In the traditional route, you would pay off the mortgage on your family home first before then building an investment portfolio. However taking this route means that you are sacrificing the compounding returns you would have gained had you started building your investment portfolio earlier. When you consider that it would take a number of years for the everyday family to completely pay off the average mortgage, the returns you potentially missed out on could have a significant impact on the likelihood of you achieving your financial goals.

We mentioned it before but debt recycling also has considerable tax benefits which are especially useful for high income earners. Since this strategy is geared primarily around minimising your tax obligations and maximising your tax benefits, debt recycling may turn out to be more cost-effective than if you hadn’t undertaken any strategy at all. The higher your marginal tax rate, the more profitable this strategy could be for you.

Finally, utilising a debt recycling strategy can allow you to build a diverse investment portfolio from the beginning. While a more traditional investment strategy would lock you into one type of investment – for example property – until it was completely paid off, debt recycling can be used to free up extra money that can then be used to invest into shares or other diverse investment assets. This way you not only gain the benefits of compounding returns but also ensure that your wealth is spread across multiple asset types and sectors as it continues to grow, thus protecting it from any market downturns that may occur.

The Downsides of Debt Recycling

While debt recycling does have a number of benefits, there are a few downsides worth considering – especially if your strategy is not structured correctly or you don’t have the required income to support the endeavour over the long term.

The number one thing you should know before considering utilising debt recycling is that just as your returns are compounded, so too are any losses you might suffer when markets experience a downturn. To put it simply: since you have debt owing on two types of investment assets, when the market experiences a turn it’s highly likely you will experience double the fall.

When you consider that, in most debt recycling strategies, the asset that your strategy will be leveraged against will be your family home, this means you have to be extremely comfortable with the level of risk associated with this strategy.

It is also due to this heightened level of risk that debt recycling will usually only be recommended as a long-term strategy, allowing you time to recover from any market crashes that occur before you need to access income from your assets. In fact, debt recycling is usually not recommended for anyone with an investment timeframe of less than seven years, with a longer timeframe generally leading to better benefits.

Debt recycling is also a strategy that is usually most effective for those with a large, secure income who are able to comfortably service both loans and who’ll benefit the most from the tax advantages.

Even if you did fall into this category, it’s also important that you have a sufficient amount of personal protection to ensure you or your loved ones are able to continue meeting your loan repayments in case something unexpected happens.

When it comes to debt recycling, the determiner of whether there are more benefits than downsides, or vice versa, will be how it affects your particular financial situation and future investment goals. That’s why discussing debt recycling with your trusted financial professional is so important in order to help you a gain thorough understanding of debt recycling and how it may help you achieve financial security and success.

Still Unsure About Debt Recycling? We Can Help

Debt recycling is a wealth creation strategy that can be beneficial – if you are a specific type of investor who is comfortable with the level of risk associated with it as well as its rewards.

If you’re not sure about whether debt recycling is the right strategy to help you build your wealth and secure a brighter financial future, we can help.

Our team of expert investment advisors has helped those just like you make the most of debt recycling to achieve their financial goals. First, we begin by assessing your particular financial situation and short, medium and long-term financial goals before helping you to decide whether debt recycling is the right strategy for you.

But before we can do any of that, we need to get to know you a little better.

Don’t wait, let us help you continue to make smart investment decisions.

Get In Touch With An Investment Expert Today!