Debt Reduction Strategy – Good vs Bad Debt
Debt recycling
It is important to understand the difference between good debt (or efficient debt) and bad debt (inefficient debt). The best example of the latter if your home loan. It doesn’t produce an income AND it is 100% non-tax-deductible (i.e. you can’t deduct any of the property payments from your taxable income).
This leads to the next point – is there a more efficient way to pay down your home loan? What if there was a way to recycle the non-deductible (or inefficient) debt for a more efficient debt? Potentially you could use gains from this debt recycling strategy to pay down your home loan at a much faster rate. The more home loan you are able to pay off with income derived from ‘good debt’, the more you are able to redraw from your home loan to speed up the process (reducing bad debt and increasing income-producing good debt).
When your home loan is paid down, you could have an income producing investment portfolio that should continue to grow until retirement.
Here is a generalised example of how the strategy works:
- Use equity in your property (perhaps you have a redraw facility, offset account or are willing to refinance and draw out equity) for an investment loan, which now becomes tax deductible.
- Use this money (that has effectively been borrowed against the home) to invest in an income-producing asset, most commonly shares or an investment property
- Use the income generated, plus the tax advantages of a geared investment that comes in the form of a tax refund, to pay off your home loan
- Keep increasing your investment borrowings by the same amount that you pay down your home loan, and continue to invest in income-producing assets
- Continue this process annually until your tax-deductible debt has entirely replaces your home loan. You are then able to sell the investments you have purchased (as there has hopefully been capital gain) or continue to receive the income that they generate.
Send an enquiry to Perceptive Finance if you would like to know how this strategy can work for you.