What if you could turn your bad debt into good debt and pay off your home loan even faster? In this article, we explore debt recycling, a powerful strategy that allows you to leverage your home equity to invest in income-generating assets, reduce taxes, and build a multi-million dollar portfolio. Ready to grow your wealth and pay off debt faster? Keep reading!
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What if there was a way that you could turn your bad debt into good debt and effectively pay off your home even faster?
In this article, I'm going to share with you the concept called debt recycling.
I'm going to break it down, simplify it, and show you exactly how you can do it to grow your multi-million dollar portfolio.
If you’re interested in my thoughts, definitely keep reading.
Let’s focus on the following:
Most people who own their home have debt attached to it, and unfortunately, with the current tax laws here in Australia, you can’t claim a deduction against the repayments you make.
Now, good debt and bad debt…
The easiest way to understand this is that good debt is income-producing, whereas bad debt is the opposite, which is non-income-producing and sometimes takes money out of your pocket.
Therefore:
This could be something like an investment property or taking out debt to buy shares.
Bad debt, on the other hand, is having your own property because you can't claim against it, and it doesn’t produce an income.
If you go by Robert Kiyosaki's definition of what an asset and liability are, he would say that:
I've said it in my previous blogs and YouTube videos before, and I agree with that to a certain extent because a liability would take money out of your pocket.
Now, if you hold a property that you live in, it's taking money out of your pocket as it’s non-income-producing.
However, you can take the equity from your property to purchase multiple properties, so it's gaining equity and capital growth, meaning it would technically be an asset.
By that definition, if you think it’s an asset and you want to know how to build a portfolio with equity (so you can put no money down), definitely go check out this blog where I break it all down for you. You can mark it and come back to it later.
Now, most people would have their home loan structured like this: they put a portion of cash towards the purchase of their home, sometimes 5%, sometimes 25%, and the rest is debt.
The reason this is shown in red is that debt is generally considered bad.
Technically, in this case, it is bad, but we’re going to try to turn the bad into good.
The reason it's called bad debt is because there are no tax deductions.
Now, when you get into an investment property, you can see that the debt is actually shown in green, not red. (I’ll come back to that in a second.) You could use equity or cash to purchase this property.
However, the reason it's considered good debt is because you can claim tax deductions against the expenses.
Now, I’ve mentioned it a few times, so what does it actually mean?
Let’s look at an assumption here.
Before I get into the deductions, I’m going to show you an assumption we can make before we dive into the details.
Let’s assume that your home has $500,000 worth of debt.
At a 6.5% interest rate, that would mean about $32,000 is coming out of your pocket towards repayments at the end of the year. There are no deductions, so if your income is $100,000, the tax you’re going to pay is based on your salary of $100,000.
Now, let’s look at an investment property.
Let’s assume the same numbers—$500,000 and a 6.5% interest rate—meaning $32,500 goes towards interest repayments.
In this case, if your salary is again $100,000, because you have a deduction of $32,000, it would effectively mean that the Australian Taxation Office (ATO) is now going to assess your income at $67,500 instead of $100,000.
This is very important because, in Australia, as you know, there are tax brackets. You could suddenly drop from one tax bracket to another, which could dramatically change how much money you’re left with at the end of the year.
Now, you’ve got to keep in mind that you need to add back the rent and subtract other costs. This number here—$32,000—is just your interest repayments. You also have:
These would add to this number here, further reducing your taxable income.
Yes, you’ve got rent coming in. If you’ve got positive cash flow, it’s actually going to add to your income, and you will pay slightly higher taxes. But for most people, right now, in the first couple of years of owning a property, you’re probably going to get the benefits of negative gearing.
Although that’s a hotly contested argument—whether it's going to stay or be cancelled—you should check out this blog where I share all my thoughts around the tax changes that could be coming and affecting you, even if you are a renter, because it will affect you.
In this case, we know that we've got good debt and we've got bad debt.
Now, what's the solution? Because right now, I have a home, I have equity in it, I have put my cash towards it, but I have debt. I want to make that debt start giving me some deductions, and there is a way.
The solution is that you could use the equity from your home to go and purchase an investment property.
Now, the equity here is now tax-deductible, which is very important.
So, I'm going to break down how this actually works.
We know that the home debt you have here is not tax-deductible.
The home equity, as it currently stands, is not tax-deductible because there's no debt attached to it.
However, if we now use this as equity to go and purchase our investment property, it becomes tax-deductible.
So, if we use $100,000 from our equity in our home, we would then be paying about $6,500 on the interest repayments. But more importantly, this is the difference between owning one house by itself, which is what you live in, and then going and being able to purchase an investment property.
Although this concentrates on just the deductions, which makes you think: Oh my God, I get a bit of tax back, you've got to focus on what that means for your wealth-building opportunity.
We've helped so many clients who have held their own homes for a couple of years. They've gained some equity, but it just sits there. They have no other investment properties and don't know how to move from one property to five or six.
They've used the equity to purchase multiple properties. That's how you create large wealth and generational wealth.
Therefore, in this case, yes, you get the benefit of the $6,500 that would offset your taxes. But now, because you have an investment property, you're probably taking out another $500,000 worth of debt—and that’s the big 'D' word that you absolutely hate.
In some cases, you love the 'D' word, but not in this case. In this case, that debt would still be tax-deductible because you're using it for productive assets.
The next step here is to say: Okay, Ravi, I’ve understood that I can use the equity in my home, take out that equity, and then purchase an investment property—whoop-de-do.
Well, that's level one, my friend. Level two and level three are what I'm about to explain now.
What you can do is use the equity from your home and go and purchase multiple investment properties.
Why would you do this?
Simple! Because all of these properties will eventually generate an income, especially if you go interest-only. This is why we have this strategy. You want to keep productive debt and get rid of non-productive debt.
If you went interest-only, interest-only, interest-only, but paid interest plus principal here, all the surplus cash that you generate from these investment properties would go straight into paying off the non-tax-deductible debt. That's exactly what you want.
So, what you do is you take the rent from your investment properties, and it goes straight into paying off the debt on your home.
This thereby creates more equity, and that equity can then be repeated to go and purchase more investment properties—four, five, six, and so on.
What you're doing is paying off the debt against your home, therefore getting into a position where you only hold good debt. This strategy is used to pay off your home even faster.
Just to recap everything we've spoken about so it makes a lot of sense:
Our home has debt in it, and that's okay. We also have equity, which we can use to purchase investment properties. By doing this, the equity we take from our home is now turned into tax-deductible debt, meaning we can claim against it.
Once you do that, you have the opportunity to just rinse and repeat.
What you'll find in 10 to 20 years is that your investment properties have grown so much that you can eventually sell a couple of them to pay down all of the debt against your home. You could then go and refinance your home, take out that money, and buy more investment properties if you wish to.
Of course, there are transaction costs and other considerations, but again, your focus is not just on reducing your taxes; it's about gaining wealth.
If you build wealth the right way, you can reduce your taxes as well. This is why I make these articles (and videos) here every single week. I'm here three times a week, and yes, when I'm not here, my full-time job is running Search Property, the buyers' agency, which is one of the leading buyers' agencies in all of Australia. So, if you need help and want to move at speed, you definitely want to contact us, book a FREE discovery call with my team and we can get you started.
I hope you guys enjoyed this article. I'll catch you guys in the next one. Thanks, guys!
Disclaimer: Search Property Pty Ltd (SP) does not provide financial or investment advice and does not hold a financial services license as defined in the Corporations Act 2001 (Cth). Any advice given by SP is general in nature and does not take into account your personal circumstances or objectives, financial situation or needs.
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