Turning bad debt into good debt is likely something you have heard about but when you think of bad debt, you may be thinking about your credit cards or a small loan. However, one bad debt you may not have considered is your mortgage. While owning a home does have its benefits, it is also not tax-deductible and does not guarantee a good investment into the future. If you want to turn that bad debt into something good, you may want to consider debt recycling.
What Is Debt Recycling?
At its most basic, debt recycling is the process of replacing mortgage debt with investment debt, turning it from non-tax deductible (bad) to tax deductible (good). From the outside, it may look like you are simply swapping one loan for another. However, it actually has several benefits for those willing to take a calculated risk. It is important to remember that this tactic isn’t for everyone and understanding how it can work for you is crucial.
The Pros and Cons of Debt Recycling
Debt recycling can be an amazing option in the right scenario. Weighing up the pros and cons of debt recycling can help you figure out if this could be a good move for you.
One of the main reasons people choose to commit to debt recycling is the immediate change from bad to good debt, allowing you to build out your investment portfolio and grow your wealth much faster than more traditional options. Another positive is the tax benefits it offers. This is particularly beneficial for high income earners as it can minimise your tax obligations and maximise the benefits. Debt recycling can also help you pay off your home loan faster, saving on interest.
Finally, debt recycling also allows you to diversify your investment property portfolio earlier. Many investment strategies lock you into a particular type of investment, like property, while debt recycling frees up funds that can be used to invest how you please, such as shares. This spreads the wealth across multiple asset types, which can protect (to a degree) you from market downturns.
On the other end of the spectrum, there are some downsides to debt recycling to be aware of. For example, while returns are compounded, this means any losses from a downturn are also compounded. Having diversified assets will help but this can have a significant impact depending on how much you diversify your investments. Due to this and the fact that the diversification is coming from your mortgage, which comes with a higher element of risk, this method is also more long term and is usually not recommended for anyone who has a timeframe of less than seven years.
This kind of strategy is also most effective for those who have high earnings and secure position so they can comfortably service both loans and get the tax benefits. It is also recommended you have sufficient life insurance to protect you in the worst case scenario.
Pros and Cons of Debt Recycling
Change your bad debt to good debt
Diversify your investment portfolio
Pay off your home loan faster
Claim tax benefits
7+ years strategy
Requires adequate insurance coverage
Ultimately, how the pros and cons of debt recycling affect you is dependent on your particular financial situation, future investment goals, and if you have expert advice or knowledge to back you up.
How Offset Property Can Help
Debt recycling can be an amazing option for the right person. However, like any investment or financial opportunity, expert advice can mean the difference between a calculated risk and significant losses.
If you want to learn more about debt recycling or would like to create a plan to get started, talk to the team at Offset Property. We are property experts with significant knowledge around debt recycling in Australia, so get in touch today.