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I believe in recycling

By Paul Gillmore of Southern Cross Financial paul@southerncrossfs.com.au


In our modern society, most of us comprehend the need for recycling of the earth's precious resources. We see this as environmentally sound, ethically sound, beneficial to ourselves and families in the longer term via less wastage and more efficient utilisation of resources.

Here is a thought - What if we could do this with our home loan?

A couple of the reasons that we purchase a home or principle place of residence, other than a place within which we can live are:

1.      Capital Growth - your home increases in value,

2.      Increased Equity - equity is the amount that you own in your property/s as opposed to the amount that the bank owns, which is your home loan. That is, the market value of your home minus the amount you owe the bank equals your equity.

Equity is a wonderful thing because the value of your property generally increases over time whilst you simultaneously pay your home loan back consequently increasing your net worth. This valuable equity can then be used as collateral against which you can borrow. Of course this is nothing new but if we take this concept up a level and then systematise it, we create a concept known as Debt Recycling.

Debt Recycling

If we have a home loan of say, $300,000, and we have paid it down to a balance owing of $150,000, by keeping the upper limit at $300,000, we have $150,000 that we can borrow. That is, we can effectively re-use or recycle that debt.

Whacko! Let's go and buy a new car, a pool and have an overseas holiday!

Yes, you could do that and many people do but it could be counter productive to your wealth building strategies. I'm not saying don't buy a new car or have a holiday, I am saying ‘don't derail your hopes, plans and dreams with self sabotaging financial behaviour'.

Alternatively, we could systematically invest into growth and income investments utilising the equity available to further increase your net worth. Sounds boring, right? Not when you see your investments grow in value over the next 6 to 12 months and onwards from there.

Is this Magic?

Something special is now about to happen. The taxman is now going to pay you for some of the costs of your investments. This includes interest on the recycled debt amount and costs of holding the investments.

Do you get a tax deduction for the interest you pay on your home loan? Noooo....

But you do get a tax deduction for the cost of buying and keeping your investments quite simply because you will pay tax on them in the future. We all know these taxes as Income tax and Capital Gains tax (CGT). But don't despair, there are legal and moral ways to minimise these taxes.

Key Concept: Please don't avoid investing because you might pay tax... similarly, please don't invest in something for the sole reason that you will get a tax deduction.

A good investment stands up to scrutiny on its own so please consider any tax benefits as a bonus.

Moving Forward

Moving forward from here, as we pay our home loan down, we simply borrow against that increased equity to buy some more investments. This effectively increases the ratio of the investment amount, to the home loan amount. This is called ‘paying off non-deductible debt'. That is, we are paying back the debt that we cannot get a tax deduction (non-deductible debt/home loan) and replacing it with debt that we CAN get a tax deduction (investment loan).

 We do this until we have no more non-deductible debt. Meaning that your home is now paid off and you only have loans for your investments. Don't forget that your home is still going up in value AND so are your investments, thus increasing your total equity and net worth.

I think you will agree that this is a major step towards YOUR FINANCIAL FREEDOM.