Debt Recycling Strategies: How They Can Reduce Your Debt and Build Wealth

Historically, business owners have been cautioned against building up too much debt, with wary business owners fearing it may hamper cashflow and stifle business growth. But not all debt is bad, and with the right strategy, you can use your current debt to build wealth, reduce debt and save money. Debt recycling is one of these strategies.

Debt recycling is a financial strategy that lets you turn your non-tax-deductible debt (bad debt) into tax-deductible debt (good debt) that you use to generate income or returns. And yes, it’s legal!

Here at PCR Accounting & Advisory we can help you figure out whether debt recycling is the right strategy for you and recommend the best debt recycling strategies to reduce debt and build wealth.

How Debt Recycling Works

Debt recycling is, quite literally, recycling bad debt into good debt. While it sounds too good to be true, it does require expert guidance, financial discipline and proper planning to see debt recycling work to its full potential.

Non-tax-deductible debt is what’s referred to as bad debt, with a home loan or mortgage being the most common type. Because this debt is not used for generating income, you cannot claim a tax deduction on interest payments.

But if you use money you’ve borrowed for investments and other income-generating activities such as shares or an investment property, it is tax-deductible. This is what’s called good debt.

In debt recycling, you replace non-tax-deductible debt with tax-deductible debt, bit by bit until you are left with just the good debt. It is a years-long process that requires careful planning. But when done right, you can make significant tax savings while growing your wealth.

Say you have a $500,000 home loan, which is non-tax-deductible. Here’s how you would go about recycling this debt.

1. You take $100,000 from your savings or surplus funds and pay part of the loan. This leaves you with a $400,000 loan.
2. You then use your lender’s redraw facilities to get the $100,000.
3. Put the money towards investments or any income-generating activity. Examples include shares or a rental property. $100,000 of the existing loan is now tax-deductible.
4. Use the income or investment returns plus tax savings to make extra payments towards the remaining $400,000 of non-tax-deductible debt. Once you pay off another chunk, you can redraw again and use it towards income-generating activity.
5. Keep going until you have replaced your entire home loan with tax-deductible debt.

This is just a rough example; the specifics will vary depending on your loan terms, how much debt you have and other factors.

Debt Recycling vs. Leveraging Debt

You may be wondering why you don’t just take a fresh loan for investment without having to pay off part of your current loan. After all, you can still claim tax deductions on the new investment loan.

That’s not debt recycling; it’s leveraging debt. It may be an option for some businesses, but it comes with risks. It adds to your total debt (debt recycling keeps total debt the same), which can further affect your cashflow. You also don’t enjoy tax savings on your home loan. We can advise on what debt strategies are most suited to your needs and goals to ensure you make the most of your borrowing.

Benefits of Debt Recycling

1. Tax Savings

You’d need to sit down with an accountant to figure out exactly how much you stand to save in taxes, but debt recycling can accrue significant savings over several years.

These savings can free up cashflow, or you can use them to pay off more of your non-deductible debt.

2. Wealth Generation

By recycling debt and smartly investing the newly borrowed funds, you can build wealth faster compared to only paying off your current debt.

3. Quicker Debt Reduction

Using income from your investments and the savings you make from tax deductions, you may be able to pay off your current non-deductible debt sooner. This saves you interest payments, allows you to build your home equity and improves cashflow.

Debt Recycling Risks and Considerations

Debt recycling is not without risks, and you should consult with a professional to create a strategy that protects your wealth while maximising tax benefits and investment returns.

Some of the considerations to keep in mind include:

• Your investments may underperform, leaving you with debt repayments with little or no returns.
• Debt recycling is a long-term strategy that requires patience. If you want a quicker way to reduce debt and build wealth, it may not be the best option.
• Depending on the types of investments and income-generating activities you choose, debt recycling requires a fair amount of risk tolerance.
• Debt recycling only works if you have cash on hand to repay or offset part of your current loan. Using this money can cause temporary cashflow shortages before you get any returns from your investments.

Specialist Debt Advisors at PCR

The most important thing when it comes to debt recycling is having an expert by your side to help you do it right. At PCR, we have specialist debt advisors who’ll guide you through the complexities of debt recycling to ensure the best outcome for your future.

Contact us at 03 9847 7516 to get a tailored debt recycling plan.

Disclaimer: This blog post is for informational purposes only and should not be considered as financial or legal advice. Consult with a qualified professional for personalised guidance based on your specific circumstances.