Debt Recycling Australia | How To?

At its core, debt recycling isn’t about some clever loan hack or tax loophole — it’s about changing the nature of your debt while transferring the financial burden from your future self to an investment engine you build today.

You already owe money (on your home). Instead of treating that debt as a static liability, debt recycling turns it into a financial lever:

• Your home loan is a drag (cost only, no income).
• Investment debt can be productive (cost + potential income + tax deductions).

Debt recycling is about reallocating the balance between these two without increasing your overall out-of-pocket costs too dramatically.

What’s Debt Recycling Australia?

Debt recycling is an advanced personal finance strategy primarily used in Australia to accelerate wealth building and reduce tax liabilities.

It involves converting non-deductible debt (such as interest on a home loan for your principal place of residence, or PPOR, which isn’t tax-deductible) into deductible debt (interest on loans used for income-producing investments, like shares or rental properties, which is tax-deductible).

By leveraging the equity in your home, you can “recycle” portions of your mortgage into investments that generate returns while claiming tax benefits on the interest paid.

This approach is often discussed in financial communities like Reddit’s r/AusFinance, where it’s praised for its potential to pay off your home faster while growing an investment portfolio.

However, it’s not a one-size-fits-all tactic and carries risks, especially in volatile markets or with rising interest rates.

How Does Debt Recycling Work?

1. Start with a home loan — This is typically non-deductible because it’s for personal use.

2. Build equity — As you pay down the home loan or as the property value grows, your equity increases.

3. Borrow against equity — You use the increased equity to take out an investment loan.

4. Invest the borrowed funds — This could be in shares, managed funds, investment properties, or other income-producing assets.

5. Use investment income (and any tax benefits) to help pay off the home loan faster.

6. Repeat the process — Over time, the amount of non-deductible home loan debt decreases, and investment assets (and deductible debt) increase.

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Realistic Example On How To Debt Recycle In Practice?

Step 1: Restructure the Loan

Alex sets up:

1. A standard home loan for the existing $500,000 mortgage.

2. An investment loan facility (e.g., a line of credit or split loan), initially for $0 but with borrowing capacity of up to $200,000 based on equity.

This means Alex has:

• Non-deductible home loan: $500,000
• Investment loan: $0 (to be drawn gradually)

Step 2: Start Debt Recycling Cycle

Each month:

• Alex pays the minimum required payment on the home loan.
• Plus, Alex uses their extra $1,000 cash flow to make an additional repayment on the home loan.

Let’s say after the first few months, Alex has paid down $10,000 extra on the home loan.

Step 3: Re-Borrow That Equity to Invest

Alex then:

• Redraws or borrows $10,000 from the investment loan (not from the home loan).
• Invests that $10,000 into a diversified portfolio (e.g., ETFs or managed funds).

Now:

• Home loan = $490,000 (non-deductible, shrinking).
• Investment loan = $10,000 (deductible, growing).
• Investment portfolio = $10,000 (income-generating asset).

Step 4: Investment Income Works for Alex

If that $10,000 investment earns:

• 5% yield = $500/year income.

Alex:

• Uses that $500 investment income to make additional payments on the home loan.
• Claims the interest on the $10,000 investment loan as a tax deduction.
• Continues to direct their $1,000/month toward paying down the mortgage.
• Next cycle, Alex has more equity to re-borrow and invest again.

Step 5: Over Time — The Shift Happens

After 10 years of repeating this:

• Home loan might be fully paid off (non-deductible debt = $0).
• Investment loan might have grown to, say, $200,000.
• Investment portfolio might have grown to $300,000+ (through contributions + compounding growth).

Alex has converted bad debt into good debt and built a solid investment base along the way.

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What Is The Best Investment For Debt Recycling?

There isn’t one “best” investment for debt recycling.

Instead, the best investment depends on the role it plays inside the debt recycling engine.

First — What the Investment Needs to Do in Debt Recycling

When you recycle debt, your investment isn’t just about making a return.

It needs to:

1. Generate income (ideally, to help pay down your non-deductible home loan faster).

2. Be eligible for tax deductibility (the borrowed funds must be used for an income-producing purpose).

3. Be reasonably stable and long-term, because this is a compounding strategy.

4. Allow flexibility — so you can add to it over time as more debt is recycled.

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Why Shares and ETFs Are Popular for Debt Recycling

1. Regular income: Many Australian companies pay fully franked dividends, which can provide cash flow to accelerate mortgage repayments.
2. Ease of scaling: You can invest gradually as you recycle more debt (you don’t need to borrow $500k in one go like property).
3. Liquidity: If things go sideways, it’s easier to sell part of a share portfolio than to offload a property.
4. Tax benefits: Franking credits can enhance after-tax returns.

Which Debt Recycling Is More Profitable?

When people ask “Which debt recycling strategy is more profitable?”, they’re really asking:

👉 “Which type of investment gives the best long-term return after tax, after interest costs, and after risk?”

There’s no single answer because “profit” depends on several moving parts: the investment performance, interest rates, tax outcomes, and your personal cash flow.

But we can break it down by the main types of debt recycling strategies and what typically drives profitability.

1. Debt Recycling into Shares / ETFs — “The Dividend Engine”

How it works:

• You borrow against home equity and invest in shares or ETFs.
• Dividends and franking credits help offset loan interest.
• Over time, the portfolio grows through reinvestment and capital gains.

Profitability drivers:

• Long-term capital growth (historically 7–10% p.a. for diversified equities over decades).
• Franked dividends give a tax benefit, improving after-tax return.
• Lower transaction costs and higher liquidity.
• Compounding starts early.

✅ Why it can be more profitable:

• Compounding starts fast and scales smoothly.
• Low overheads compared to property.
• You can diversify, reducing concentration risk.

⚠️ Risks:

• Market volatility can affect returns in the short term.
• Requires emotional discipline not to panic in down years.

👉 Typical net return range: 6–9% p.a. after costs, over long periods (can vary).

2. Debt Recycling into Investment Property — “The Leverage Play”

How it works:

• You recycle debt by buying an investment property.
• Rent helps service the loan; capital growth builds equity.
• Interest can be tax deductible.

Profitability drivers:

• Capital growth in a good location.
• Rental yield.
• Ability to use high leverage (big upside in rising markets).

✅ Why it can be profitable:

• Property values can compound significantly over long periods.
• Leverage magnifies gains.
• Tax deductions can be substantial.

⚠️ Risks:

• High entry costs (stamp duty, legal fees, maintenance).
• Vacancy risk and illiquidity.
• Market downturns can magnify losses.
• Not easy to “scale” gradually.

👉 Typical net return range: 4–8% p.a. depending on growth, yields, and costs (can be higher or lower).

3. Hybrid Debt Recycling (Shares + Property) — “Balanced Engine”

How it works:

• A property or home equity is used as security for both a share portfolio and/or additional property investment.
• A mix of income (dividends, rent) and growth assets supports the strategy.

✅ Why it can be profitable:

• You balance stable cash flow (shares) with long-term growth (property).
• Reduced single-asset risk.
• Flexible to adjust over time.

⚠️ Risks:

• More complex to structure.
• Requires active cash flow management.

👉 Typical net return range: 6–10% p.a. over time, depending on asset mix.

What Usually Wins Long-Term

1. Shares/ETFs debt recycling tends to outperform on a net profitability basis because it’s cheaper to enter, easier to scale, and tax efficient with franked dividends.
2. Property debt recycling can outperform in a strong property market, but the costs and risks are higher, and it’s less flexible.
3. Hybrid approaches smooth the ride and can be very effective for steady builders.

But the most profitable strategy isn’t just about returns — it’s the one you can sustain without blowing up your cash flow or taking on more risk than you can handle.

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Frequently Asked Questions

1. What exactly counts as “debt recycling”?

• Debt recycling is using the equity in your non-deductible home loan (for your principal place of residence) to borrow money for income-producing investments. The interest on that borrowed money then becomes tax-deductible.
• Example: Extra repayments on your $600k home loan → redraw $50k → buy $50k of shares → interest on that $50k becomes deductible.

2. Do I need a special loan for this?

Yes – you need:

• Variable rate loan (fixed rates usually don’t allow redraw)
• Redraw facility
• Offset account (optional but helpful)
• Loan splitting capability (to separate deductible/non-deductible portions)
• Popular banks: CBA, Westpac, NAB, ANZ, plus specialist lenders like loans.com.au.

3. Can I do this with an investment property loan?

• No – debt recycling specifically converts non-deductible (home loan) debt into deductible (investment) debt. Investment property loans are already deductible.

4. What investments qualify for deductions?

Must produce assessable income:

• ✅ Dividend-paying shares/ETFs
• ✅ Rental properties
• ✅ Managed funds with distributions
• ❌ Your car (no income)
• ❌ Super contributions (not assessable income)
• ❌ Personal use assets

5. How do I prove to the ATO which interest is deductible?

Critical record-keeping:

• Split your loan – have separate “PPOR loan” and “investment loan” portions
• Document every redraw – date, amount, purpose
• Keep investment statements showing purchases match redraw amounts
• Interest attribution – track exactly which loan portion funded which investment
• Pro tip: Use loan splitting over redraw-only. Redraw gets messy during ATO audits.

6. What happens if markets crash? Can I still claim deductions?

• Yes – deductions are based on loan purpose, not investment performance.
• Example: Borrow $50k for shares → shares drop 30% → you still deduct the $3k interest because the purpose was income production.
• But: Capital losses can offset gains elsewhere.

7. Joint loans with a non-working spouse?

• Yes – the working spouse can recycle their portion.
• Example: $600k joint loan, you earn $120k, spouse earns $0. You can recycle up to your contribution portion (often 50/50 unless documented otherwise).

8. What’s the biggest risk?

• Leverage amplifies losses. If shares drop 30% while you’re paying 6% interest, you’re underwater on that portion.
• 2022 example: ASX 200 fell ~15%, bonds yielded negative returns. Debt recyclers with 70% LVRs got nervous.

Mitigation:

• Start small (10-20% of equity)
• Use blue-chip ETFs (VAS, VGS)
• Keep 6+ months emergency fund

9. What if interest rates rise?

• Cash flow becomes the issue. At 3% rates, $50k costs $1.5k/year interest. At 7%, it’s $3.5k/year.
• Stress test: Can you service the full loan at RBA cash rate + 3% (buffer)?

10. Can I do this if I’m close to retirement?

Generally no. Debt recycling needs:

• 10+ year horizon
• Stable income
• Tolerance for sequence-of-returns risk
• Better for: 30-50 year olds with career stability.

11. Should I pay down debt first or invest aggressively?

• Hybrid approach works best:
• Build 3-6 months emergency fund
• Pay to 80% LVR (avoids LMI)
• Start recycling small (10% of equity)
• Scale up as you get comfortable

Rule of thumb: Only recycle what you’d invest without debt.

13. How much can I realistically recycle?

• Conservative: 20-30% of home equity Aggressive: 50-70% (high risk)
• Example: $800k house, $400k loan = $400k equity. Recycle $80k-120k conservatively.

13. Offset vs redraw – which is better?

• Offset: Better long-term. Reduces all interest (deductible + non-deductible).
• Redraw: Faster recycling but only reduces non-deductible portion.

Best: Use offset for surplus cash, redraw/loan split for recycling.

14. Can I recycle inside a family trust?

Yes – actually preferred for:

• Asset protection
• Income splitting
• CGT discount preservation

Process: Trust buys shares/property using loan funds. Trust pays interest to you, you claim deduction.

15. What about negative gearing?

Debt recycling is negative gearing, but positive.

• Traditional negative gearing: Buy loss-making property, claim losses against salary. Debt recycling: Convert non-deductible debt → deductible debt → tax savings compound.

16. How do I calculate if it’s worth it?

• Simple breakeven: Investment return > loan interest rate × (1 – your tax rate)
• Example: 6% loan, 37% tax bracket, 8% share return
• After-tax loan cost: 6% × (1 – 0.37) = 3.78%
• Investment return: 8%
• Spread: 4.22% positive carry

17. Can I reverse debt recycling?

• Yes – sell investments, repay investment loan portion first. Remaining home loan interest becomes non-deductible again.

ATO rule: Must repay specific investment loan portions before claiming further deductions