Debt recycling: What is it, and how does it work?
Debt recycling is a method that seeks to help you pay off non-deductible debt (such as a mortgage) as rapidly as feasible while simultaneously increasing your wealth in a tax-efficient manner over time. It entails replacing or recycling your mortgage debt with tax-deductible debt from investments. If you are looking for a lender who can help you with your debt or consolidation visit https://citrusnorth.com/.
How does it work?
This technique is using the equity in your house to invest in income-generating assets that have the potential to expand. The returns from these investments could be applied to your house loan over time, allowing you to pay it off faster than if you merely made regular payments.
Interest on investment loans is usually tax-deductible. This technique has the potential to save you money on taxes, which you may put toward your mortgage. Furthermore, if the value of your new investments rises, you will be increasing your wealth simultaneously.
The idea is to increase your investment loan by the same amount you paid off your home loan after the first year and reinvest the difference. The goal is to keep repeating this process every year until your investment loan completely replaces your mortgage.
What are the potential dangers?
Debt recycling is a high-risk technique because you’re investing with borrowed money and securing the debt with your own house. If your investment underperforms or interest rates rise, you may be in severe financial trouble, putting your family’s home in jeopardy. Before getting into this method, it’s critical to consider the following points:
- When markets are rising, borrowing money to invest can result in larger gains. When markets collapse, your losses will be greater because you must still pay interest and repay the loan. If your loan’s interest rate isn’t fixed, a rise in interest rates may cause your repayments to increase. This might strain your cash flow, which can be exacerbated if your investment income is smaller than projected.
- Assets purchased with borrowed monies may lose value. This means that, even if you obtain tax benefits from the investment over time, the asset may lose value and you may remain in debt even after selling it.
- Using the investment income and tax savings for your home loan each year, rather than spending it on a ‘desire’ like a vacation or new car, requires resolve and discipline.
- If you decide to go ahead with this plan, check your insurance coverage to make sure the extra debt can be returned if something occurs to you.
Checklist for Debt Recycling
To make a debt recycling strategy work, you’ll need:
- A house loan with equity in your home
- A regular source of income that is unrelated to the debt recycling approach. This income can provide enough cash flow to satisfy your investment loan’s interest obligations.
- A commitment to long-term investing
- A readiness to take on more debt and keep an investment loan
- Consider income protection insurance, which may give replacement income if you become unable to work due to illness or injury.
Debt consolidation isn’t for everyone. It’s critical to understand all of the hazards associated with this method if you’re contemplating it. Obtaining financial guidance may assist you in determining whether or not this technique is appropriate for you.