Debt Recycling Calculator Explained
Have you ever heard of debt recycling and the tools used for it, like a debt recycling calculator? If you haven’t, you’re in luck! This article will help you understand what it is and how it can be used.
Now, everyone can agree that debt is terrible, but saying no to a new credit card with “6-months interest-free” is often difficult to do. This is probably why, to date, there are 12.13 million credit card accounts in Australia and around $20.1 billion in debt accruing interest. This can also be one reason why nearly half of the adult population in the country is in debt.
Being in debt can feel stressful and overwhelming, but it’s not all bad news – there’s a smart strategy called debt recycling that can turn things around. With the help of a debt recycling calculator, you can see how this strategy might work for you. If you want to learn how this works, read on.
Good Debt vs Bad Debt: What’s the Difference?
You should know, not all debt is bad. In fact, some can actually help grow your wealth. Good debt is used for things that can increase in value or generate income. These include investment property loans or student loans that can boost your earning potential. These types of debt often come with lower interest rates and may even offer tax benefits, making them useful tools when managed well.
Bad debt, on the other hand, is usually linked to spending on things that lose value or don’t earn you money. Examples include credit card debt, payday loans or car loans for luxury vehicles. This kind of debt often comes with high interest rates and can quickly become a financial burden. By understanding the difference and using smart strategies like debt recycling, you can start shifting your financial position from debt stress to long-term wealth creation.
What is Debt Recycling?
So, what is debt recycling? According to Michael Yardney (a multi-award-winning property investment advisor), it is “a sound investment strategy” that can help you build personal wealth.
How does it work? When you borrow against the equity in your existing property and then use those funds to invest in income-generating assets (like rental property), you essentially turn what you borrow (your debt) into a money-making venture. This debt is tax-deductible and can provide an ongoing income (usually in the form of rent).
The income from your investment can then be used to cover your mortgage repayments. Once you build up more equity, the cycle can then be repeated, thereby resulting in wealth generation through debt recycling.
Should You Use A Debt Recycling Calculator?
As with any kind of financial strategy, debt recycling involves a certain level of risk. One key element is ensuring that you can manage the added debt successfully. Because of this, some potential investors turn to a debt recycling calculator to estimate their potential costs vs. returns.
While an online debt recycling calculator can be useful as a predictor of possible returns, it’s important to remember these tools are generic by design. This means that such tools can’t offer advice tailored to your financial situation.
This is why it’s a good idea to talk to an experienced mortgage broker before you decide to implement a debt recycling strategy.
How to Use Debt Recycling to Build Wealth?
A good debt recycling strategy involves taking necessary debt (your existing mortgage) and then using it to create good debt. The process works like this:
- You first begin by calculating home loan equity in your existing home and using it as a deposit for an investment property loan.
- With such equity loans, you buy an investment property.
- This investment property delivers immediate income (in the form of rental returns), which can then be used to service loan repayments.
- You continue to pay off your investment property loan while also paying down your home loan. Both properties experience long-term capital growth, increasing the total value of your assets.
- By the time you’re ready to retire, you’ve paid off both loans. This leaves you with a home you can live in and an investment property that will provide a steady income stream throughout your retirement.
How a Debt Recycling Calculator Strategy Works
A debt recycling calculator is designed to help you model potential scenarios. To do this, you need to input key figures related to your existing home loan into one of these calculators. These can include equity and repayments, as well as potential investment amounts.
Based on your expected returns and tax rate, the calculator can provide estimated projections such as:
- Potential tax savings from deductible interest on the investment loan
- Projected growth of your investment portfolio over time
- The potential impact on how quickly you could repay your non-deductible home loan
- An estimate of your net financial position over the long term
A debt recycling calculator is a great tool to help you understand how the strategy works and what it might achieve. But keep in mind – it can only give you an estimate. It relies on the information you enter and can’t predict personal factors, interest rate changes or lender rules. It’s a helpful starting point, but it’s not a replacement for personalised financial advice.
So, what does debt recycling actually look like? Here’s an example:
Shannon, a homeowner in Brisbane, has a $500,000 mortgage and $200,000 in equity. After chatting with a mortgage broker, Shannon uses that equity to invest in a $400,000 rental property. The rent helps pay off the investment loan while Shannon also continues paying off the home loan.
Eventually, both loans are paid off. This leaves Shannon with a fully owned home and an investment property that brings in steady income. It’s a smart move that helped build long-term wealth, which now funds a comfortable retirement. Now Shannon can celebrate by buying a new boat!
A Gold Coast Finance Broker Can Help with Your Debt Recycling Strategy
A debt recycling calculator can give you a helpful overview, but the strategy needs to be done right. Poor loan setup or mixing personal and investment funds (known as ‘loan contamination’) can lead to lost tax benefits and added risk. Since debt recycling involves borrowing to invest, it also comes with risks like market changes and interest rate fluctuations.
At Professional Lending Solutions (PLS), our finance brokers can tailor lending solutions to your goals, finances and risk tolerance. After using a debt recycling calculator and before you consider debt recycling, it’s important to get advice from a trusted expert. Contact us today to discuss how a well-planned debt recycling strategy could help you
Phil’s journey from banking to mortgage brokering reflects a career driven by a commitment to personalised service and tailored financial solutions. With a distinguished background in banking, including roles at NAB, ANZ and Lloyds TSB Bank in the UK, Phil spent 12 years developing expertise in personal and commercial finance, while also completing a Bachelor of Business (Finance), followed by an MBA majoring in International Business.