Debt Recycling and why it’s important to property investing!!
Today we are going to be discussing debt recycling and why this can be an important part of your strategy when investing in property. Debt recycling allows you to structure your portfolio in a tax effective way whilst increasing your asset base and building wealth.
What is debt recycling?
Debt recycling is taking non-tax-deductible debt (owner-occupied mortgage) and using this to purchase an investment property which is typically tax-deductible debt. For example, accessing $100,000 equity from your owner-occupied security to use as the deposit towards an investment property purchase, which is typically tax deductible.. You should then be able claim the interest on the investment property mortgage.
If you have built up a substantial amount of equity within your owner-occupied home, this is a wonderful position to be in. If your strategy to is to grow your property portfolio, you can put that equity to work, rather than leaving it sitting there inactive.
Building your wealth base
Borrowing against your owner-occupied mortgage allows you to leverage into an investment property purchase. This is purchasing an income producing asset and if you select an area primed for growth long term this asset is going to continue to build your wealth. If this property is also positive cashflow you can then use these excess funds to help pay down your non-deductible debt, being your owner-occupied mortgage.
Potential to save tax
Please note you should always speak with your accountant/advisor for your specific situation.
Risks to consider
It’s important to mitigate these risks as much as possible by leveraging professionals to help you make informed decisions. A Buyer’s Agent can help you purchase an appropriate property by targeting areas with strong rental yields, using timing to your advantage and selecting an area primed for growth over the long term.
Let’s look at a case study to see how this works in action.
Let’s assume that we have an individual who has an owner-occupied mortgage of $500,000 and the value of the property is $1,000,000. This is a loan to valuation ratio of 50%. 500,000 / 1,000,000 x 100 = 50%. This individual has $100,000 savings which is sitting in an offset account offsetting the balance on the owner-occupied mortgage. Effectively paying interest on $400,000 being the loan balance minus the balance of the offset account.
Currently the individual can’t claim any of the expenses on the mortgage as this isn’t an income producing asset. The individual is going to purchase an investment property for $500,000 and access $100,000 of equity from the owner-occupied mortgage as the deposit for the investment property purchase. We aren’t going to consider purchasing costs to keep the exercise simple.
Now, effectively what the individual has done is borrowed 100% of the investment property purchase. This is important to note because the individual can claim all interest on 100% of the debt and expenses due to it being an income producing asset (investment property). Now looking at the investment property individually, it won’t be as positive cashflow as it could have been if a cash deposit was used for the purchase and borrowed, for example, 88% with a 12% deposit. However, this cash left in the offset account is extremely important to note.
The individual has now increased their asset base by $500,000. They now have an investment loan for $100,000 (deposit) secured by the owner-occupied debt and the existing owner-occupied mortgage of $500,000. The total debt secured by the Owner-Occupied mortgage being $600,000. Their loan to valuation ratio now being 60% on the owner-occupied property. They also have the investment property loan of $400,000. Their $100,000 cash remains in the offset account offsetting a portion of the owner-occupied mortgage, as this can’t be claimed on. They are still only paying interest on the $400,000 of non-tax-deductible debt.
Now if the individual did not structure it this way and they used their $100,000 cash deposit for the purchase they now wouldn’t be able to offset their owner-occupied mortgage by the $100,000. They would now be paying interest on the full balance being $500,000 (owner occupied debt) and not be able to claim this interest expense and the equity in their owner-occupied property would be sitting inactive.
In summation they have effectively moved $100,000 of debt from being non-tax-deductible to being tax deductible all while increasing their asset base by $500,000 and generating additional income. Using a Buyer’s Agent and ensuring a high-quality asset is selected , this will ensure longer term performance and that the property will increase in value as well as the rental income increasing long term. They have the flexibility of having access to the $100,000 in their offset account as a buffer or ultimately after using all available equity this cash could be used as another purchase deposit.
If we used interest only repayments on the owner-occupied mortgage with a rate of 3.00% this would be an annual saving of $3,000. Calculated as follows:
Interest only annual repayment on $500,000 being $15,000. Interest only annual repayments on $400,000 being $12,000. $15,000 minus $12,000 = $3,000.
This is an important strategy when investing to ensure you are building your assets creating a larger amount of wealth whilst doing this in the most tax effective way possible, ultimately creating more cashflow and increasing your tax return.
Disclaimer: Contents within this email are of general nature only and should not be relied upon solely when making an investment decision. Taylored Property Wealth nor any of its directors, associates, staff, or associated companies bear any liability from any actions derived from the contents of this email. One should always seek third party investment information from relevant parties such as legal, finance, and accountancy enquiries.