Debt recycling may be a little confusing, so let’s explain it with a
seven-step guide.
1. Over time you will have paid down a portion of your home mortgage
with a principal and interest loan and during that time your home would have
increased in value.
The difference between the current value of your home and the
outstanding amount on your mortgage is your equity.
2. The bank will often lend you up to 80% of the value of your home
as long as you can show serviceability.
3. You would take out a new investment loan using your available home
equity as security and the purpose of this loan would be to use the funds as a
deposit on an investment property.
Imagine your home is worth $600,000 and your available equity is
$300,000 because you’d paid your mortgage down to $300,000.
You could recycle $150,000 of this equity as a loan – in other words,
take out a new investment loan for $150,000 which would be then used as a
deposit for an investment property, using the equity in your home as security.
This would leave you with a loan to value ratio of 75% ($450,000 loan on
a $600,000 property) well within banks lending parameters.
4. You could use this $150,000 to invest in assets that produce both
income and capital growth such as a managed fund, shares, or as the deposit
against an investment property.
5. You could even use the income generated from your investments,
plus any tax advantages of a geared investment, to pay off the non-deductible
debt in your home loan.
6. Over time you will build your wealth as your investment property
or share portfolio should increase in value over time and the cash flow you
receive in the form of rental or dividends should also increase.
7. At the same time you will slowly be paying down the mortgage on
your home, so that when you reach your retirement years and start enjoying the
longest holiday you will have in your life, you will own your own home with no
debt and have an investment portfolio of properties or shares (preferably both)
with a manageable level of debt.
In order for a debt recycling strategy to work you need the following:
·A regular, independent income you can rely on to
deliver a surplus cash flow to cover the interest payments on your investment
loan.
·A long-term investment focus.
·A willingness to increase your debt and hold an
investment loan.
·Tolerance for risk and short-term fluctuations in
investment value.
·Income protection insurance—it may provide
replacement income in case you’re sick or injured and unable to work.
·And the financial rainy day, cash flow buffer to
see you through the ups and downs of your property investment journey – this
could be in the form of money in an offset account
So now that you understand a little more about debt recycling, you can
see that good debt isn’t really a problem – in fact, you can be an asset.
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Jason Gwerder
Thursday, 18 March 2021
