Debt Recycling Series Chapter 3: Is Debt Recycling Right For You?

Feb 18, 2025

Debt recycling is often discussed as a way to pay off a mortgage faster while building wealth through investments. But like any financial strategy, it’s not suitable for everyone. In this chapter, we’ll explore key considerations, common scenarios, and factors that may help individuals determine if this strategy aligns with their financial goals and circumstances.

⚠️ Disclaimer ⚠️

This content is for educational purposes only and does not constitute financial advice. The examples provided are hypothetical and based on assumptions. Your financial situation and results may differ. Debt recycling involves risks, including market volatility and changes in interest rates. This content does not recommend or promote any specific financial product or service. Always consult with a licensed financial advisor, tax professional, or mortgage broker to ensure this strategy aligns with your personal circumstances.

Questions to Ask Yourself Before Starting

Debt recycling isn’t for everyone. Here are six key questions to help you consider if it’s the right move for you and to work with a Financial Adviser:

1. What Are My Financial Goals?

Do you want to prioritise paying off your mortgage quickly, or is your focus on building long-term wealth? Knowing your goals will help you decide whether debt recycling makes sense for your situation.

2. Can I Handle Additional Debt?

Debt recycling may involve taking on new investment debt, such as through equity release, while continuing to manage your existing mortgage. It’s important to consider whether you’re comfortable with the added financial repayments, especially since investment returns are not guaranteed. Some individuals prefer the security of having cash in an offset account, which directly reduces mortgage interest. Additionally, if you anticipate making large purchases in the near future, investing funds that might need to be sold quickly could result in a loss if market values decline. Carefully evaluate whether you can wait for market recovery before making a decision.

3. Do I Understand How Investing Works?

Debt recycling often involves investing in assets like shares, ETFs, or property. Each option comes with unique considerations:

Property Investment: This may involve releasing equity from your home and taking on an additional mortgage unless the equity covers the full purchase price. While rental income from the property can offset some costs, it’s important to assess whether the property will be positively geared (income exceeds expenses, including maintenance and interest costs). If it’s not, sufficient cash flow is required to cover the shortfall.
ETFs (Exchange-Traded Funds): When investing in ETFs, it’s important to review the fund's diversification, long-term focus, and how it is managed or rebalanced by the portfolio manager. Understanding the underlying assets and investment strategy of the ETF can help you gauge the risks and potential returns.

If these investment options or their implications are unfamiliar, taking the time to learn more or consulting a licensed financial adviser can help you make an informed decision and minimise potential risks.

4. Do I Have a Reliable Income?

A stable income is essential because debt recycling requires consistent repayments on both your mortgage and investment loan. If your income is unpredictable, it might not be the best fit.

5. Do I Have an Emergency Fund?

Having an emergency fund equivalent to 6-9 months of living expenses can provide a financial buffer for unexpected events. While six months’ worth of expenses is a commonly referenced guideline, the appropriate amount may vary based on factors like job security, industry demand, dependants, and household income structure. For example, individuals in industries with fewer job opportunities or those with dependants may benefit from a larger safety net. A well-established emergency fund helps to manage unforeseen costs and maintain financial stability during challenging times.

6. Have I Talked to a Financial Adviser?

Debt recycling involves tax implications and investment risks. A licensed financial adviser can help you tailor the strategy to your unique situation and avoid costly mistakes.

Who Might Find Debt Recycling Suitable?

Debt recycling isn’t a one-size-fits-all solution. It may work better for some than others. Here are six common traits of people who might benefit from this strategy:

Steady Income
Having a reliable pay check helps cover loan repayments and reduces stress when juggling debt and investments.
Comfort With Risk
Investments go up and down. If you’re okay with market fluctuations and can ride out the dips, this may be worth exploring.
Long-Term Thinker
Debt recycling works best over 10 years or more. If you’re thinking about long-term growth rather than quick results, it might be a good fit.
Financially Disciplined
Keeping track of your cash flow, debt, and investments is key. If you’re good at sticking to a plan, you’re already ahead.
Equity in Your Home
If you’ve paid off part of your mortgage, you can use that equity to kickstart the process rather than needing a large cash contribution.
Savings or Investments
Extra funds in an offset account, savings, or outright investments can provide a head start, making the strategy easier to begin.

When to Be Cautious About Debt Recycling

Debt recycling isn’t for everyone. These situations might call for caution:

Unstable Income
Freelancers, casual workers, or small business owners with unpredictable earnings might struggle to keep up with repayments.
Risk-Averse Personality
If you lose sleep over market dips or worry about your investments, this strategy might cause more stress than it’s worth.
Approaching Retirement
A short investment timeline might not provide enough time to see meaningful results.
No Emergency Fund
Without 6–9 months’ worth of living expenses saved, unexpected costs could derail your financial plans.
Already Managing Debt
If current financial obligations feel overwhelming, adding more debt could increase stress and strain cash flow.
Not Familiar With Debt Recycling
It’s important to understand how this strategy works before committing. Consider seeking advice from a licensed financial adviser if it feels overwhelming.

The Benefits and Risks of Debt Recycling

Here’s a closer look at the pros and cons of debt recycling to help you weigh your options:

Benefits:

Tax Benefits: Tax-deductible loan interest and franking credits reduce taxable income.

Faster Mortgage Repayment: Use investment income and tax refunds to pay off your home loan quicker, saving on interest.

Wealth Creation: Build a portfolio of income-generating assets, with compounding amplifying returns.

Leverage: Borrowing to invest allows you to grow wealth faster than saving overtime.

Untaxed Growth: Capital growth is untaxed until sold, and gains can be minimised during low-income periods.

Flexibility: Tailor the strategy to focus on debt repayment or investment growth.

Unlock Idle Assets: Restructure cash or outright investments for greater tax efficiency.

Risks:

Market Risk: Investments can fluctuate in value, exposing you to losses.

Increased Debt: Adds financial pressure by replacing mortgage debt with investment debt.

Complexity: Requires disciplined tracking of loans, investments, and taxes.

Long-Term Commitment: Requires patience and a time horizon of 10+ years.

Potential Higher Costs: Investment loans may carry higher interest rates (Although, a mortgage broker might be able to get you the same rate as your home loan).

Cash Flow Strain: The dividend may be smaller than the interest, so you are essentially negatively-geared.

Not for Everyone: Unsuitable for risk-averse individuals, those nearing retirement, or with unstable incomes.

Final Thoughts

Debt recycling can be a powerful strategy for some, but it’s not a perfect fit for everyone. It’s all about understanding the benefits, risks, and whether it aligns with your financial situation. Taking the time to evaluate your goals, risk tolerance, and financial foundations is crucial. If you’re uncertain, speaking to a licensed financial adviser can help you decide if this strategy makes sense for you.

So, What’s Next?

In Chapter 4, we’ll explore practical examples and tips to help you decide if debt recycling is the right path for you. Stay tuned!

💬 Got a question about debt recycling? Drop it in the comments—I might include it in the FAQ chapter at the end of this series.