There is lot of talk about various strategies related to paying off debt. One such approach to paying off debt while also building wealth that you might have heard of is a debt recycling strategy. But exactly what is debt recycling? Read on to learn more about how individuals like you are using this strategy to pay off debt and increase wealth.
What is Debt Recycling and How is it Accomplished?
Debt recycling is a way to effectively convert mortgage debt into investment debt. Mortgage debt is sometimes referred to as bad debt because it is not tax deductable, while investment debt can be called good debt due to it being tax deductable. A debt recycling strategy requires that you have equity built up in your home that can then be used to purchase income generating investments, and you then use the income from those investments to mitigate the interest you pay on your home mortgage which enables you to pay off the home mortgage faster while further increasing equity in your home. This then allows you to use that equity to purchase additional income generating investments in a continuous cycle.
What is Debt Recycling in Detail?
What we just described might be a lot to take in, so let’s go over debt recycling in more detail. But before we do that, it is worth pointing out that this is an advanced investment strategy that is most appropriate for experienced investors. If you are new to investing and are interesting in a debt recycling strategy then please consult with a professional finance broker for guidance. The team at MediPro Capital Finance is here to assist you, and can be reached online or 1300 375 626.
Debt Recycling Step by Step
Step 1 – Have equity built up in your home. Home equity is the value of your home less what you still owe on your mortgage. Equity can increase in two ways, by you paying off your home loan and by the value of your home increasing. If you purchased your home in the last 7 or 8 years, then you probably have a considerable amount of equity built up. It is best if you have more than 20% of the value of your home in equity, otherwise it can be more expensive to tap into your home’s equity as you will need to purchase lenders mortgage insurance.
Step 2 – Take out a loan against your home’s equity and invest in income generating assets, such as investment properties or dividend paying stocks. This means that you will now have two loans, one that is for your home which is not tax deductable, and one for your income generating investments which is tax deductable – you will have bad debt and good debt.
Step 3 – Receive income from your investments and use that money to pay off both loans. You’ll want to pay the minimal amount into the investment loan and pay off the mortgage loan by as much as you can. This will further increase the equity that you have in your home, which can be used to borrow more money to purchase additional investments.
Step 4 – Rinse and repeat. This process cycles as you purchase additional investments you will be generating more income which you can use to further pay off your home loan, further increasing equity, and allowing you invest more in assets that generate passive income.
A Debt Recycling Example
Let’s say a family owes $250,000 on a home worth $500,000. They refinance their loan to get a $300,000 loan limit, giving them $50,000 to invest in income generating assets.
In this debt recycling example, they invest the 50k into growth stocks that pay dividends. After a year they have generated $5,000 of income which they use to make the minimal interest payments on the investment loan and use what’s left over to further pay off their mortgage. At the same time they are making regular loan payments on their mortgage, so after the year is up they now owe $240,000 on their home. They use this additional equity to increase their investment loan while investing those funds in more income generating assets. They repeat this cycle every year until they have completely paid off their home loan and built up a significant portfolio of investment assets.
An Advanced Investment Strategy
As you can see, debt recycling can be complicated and it does have inherent risks, such as the value of the investments decreasing over the short term. Therefore, it is best to consult with a professional before you implement a debt recycling investment strategy. The professionals at MediPro Capital Finance can provide you with the advice you need to determine if this advanced investment strategy is right for you. You can contact us by using our online contact form or by calling 1300 375 626 to discuss debt recycling or medical home loans.