Debt Recycling Series Chapter 4: How Debt Recycling Affects Your Cash Flow

Feb 25, 2025

Debt recycling can be a powerful strategy for building wealth while reducing your mortgage, but it’s important to understand how it affects your cash flow. In this chapter, we’ll take a closer look at the key considerations for managing your cash flow when borrowing to invest and how loan structures, repayments, and investments impact your finances.

⚠️ 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.

1. Cash Flow Considerations When Borrowing to Invest

When you redraw or borrow money for investment purposes, you take on a new loan, which has implications for your monthly repayments:

Loan Repayments: If you increase your total debt (e.g., through equity release), your monthly repayment will go up because your loan balance is now higher.
Interest-Only Loans: Some borrowers choose interest-only loans to keep repayments lower in the short term. However, this only covers the interest, so the principal amount remains the same until you switch to principal-and-interest repayments or pay it off separately.
Debt Must Be Repaid: Regardless of whether the debt is for investment or your home, it still needs to be repaid in full. Having a clear exit strategy (e.g., selling assets or paying off the loan over several years) is essential.

What Happens When You Split Your Loan?

Splitting your loan means separating it into portions for different purposes, such as one for your home and another for investments. Here’s how it affects your cash flow:

Total Monthly Repayment Stays the Same: If you split your existing loan without increasing your total debt, your monthly repayment will not change. It just get split in proportion to the loan amount.
Offset Accounts Reduce Interest, Not Repayments: Your repayments are calculated based on your total loan balance, even if you have money sitting in an offset account. For example:
- If you owe $500,000 but have $50,000 in an offset account, you’ll only be charged interest on $450,000.
- This doesn’t reduce your monthly repayment amount. Instead, more of each repayment goes toward reducing the loan principal, helping you pay off the loan faster.
Equity Release Increases Debt and Repayments: If you release equity to invest, your loan balance increases, and so does your repayment. For instance:
- If you release $100,000 on top of a $500,000 loan, your total debt becomes $600,000, and repayments are recalculated based on this higher amount.

Understanding the difference between splitting your loan and releasing equity is crucial for managing your cash flow effectively.

2. Investment Income Can Help Offset Loan Costs

One of the advantages of debt recycling is that investments can generate income, such as dividends from shares or rental income from property, which can be used to cover loan repayments. Here’s a closer look:

Positive Cash Flow: If the income from your investments exceeds the loan interest and repayments, you’ll have extra cash to reinvest, save, or reduce your debt.
Shortfalls: If the income doesn’t fully cover the costs, you’ll need to rely on your own cash flow to make up the difference. For example:
- A $100,000 investment with a 3% dividend yield and 6% capital growth = $3,000 per year in dividends and $6,000 in capital growth.
- Investment loan interest at 6% = $6,000 per year.
- Net shortfall = $3,000 per year, because capital growth isn’t realised unless you sell the investment. This means the shortfall must come from your budget or other income.

This example highlights why it’s essential to assess whether you can manage potential shortfalls in your cash flow, especially during periods where dividends or rental income may fluctuate. It's also worth considering how long-term growth from capital appreciation fits into your overall strategy, as this growth remains unrealised until you choose to sell.

3. Tax Benefits Can Improve Cash Flow

One of the advantages of debt recycling is the tax-deductible nature of investment loan interest. This can result in a tax refund, which improves cash flow. For example:

Interest Paid: $6,000 in interest paid on a $100,000 investment loan (6% interest rate).
Tax Refund: At a 37% tax rate, this results in a $2,220 tax refund when you lodge your return.
How It Helps: The refund can be used to:
- Pay down your home loan, reducing non-deductible debt.
- Reinvest to grow your portfolio further.

These tax benefits can reduce the overall cost of your investment loan and support long-term financial goals.

4. The Impact of Market Conditions on Cash Flow

Market fluctuations can directly affect the income you rely on from investments, which can have implications for your cash flow:

Dividends or Rental Income: If these are reduced during market downturns, you’ll need to cover more of the loan repayments yourself.
Emergency Fund: Commonly referenced guideline, having 6–9 months of living expenses saved in an emergency fund can provide a safety net if investment income fluctuates. However, the appropriate amount may vary based on factors like job security, industry demand, dependants, and household income structure.
Income Protection Insurance: This can ensure you’re able to meet loan repayments even if you’re unable to work due to illness or injury.

Being prepared for market volatility is essential when incorporating debt recycling into your financial strategy.

5. Debt Recycling Can Free Up Cash Over Time

Debt recycling can create long-term cash flow benefits:

Reducing Non-Deductible Debt: As you pay down your home loan, your non-deductible debt decreases, freeing up more of your income.
Building Passive Income: Over time, your investments generate more income, which can cover loan costs and even provide extra cash for lifestyle expenses or early retirement.
Financial Freedom: Eventually, the combination of reduced home loan debt and growing investment income can lead to improved cash flow and financial flexibility.

This long-term perspective is why debt recycling is often viewed as a wealth-building strategy.

Final Thoughts

Debt recycling impacts your cash flow in multiple ways, from loan repayments and tax benefits to investment income and market risks. Understanding these elements is key to making informed decisions and ensuring this strategy aligns with your financial goals.

If you’re considering debt recycling, it’s important to review your loan structure, have a solid financial foundation, and assess your ability to manage repayments and market fluctuations. A licensed financial adviser can provide guidance tailored to your circumstances.

So, What’s Next?

Next, we’ll cover the key tools you may need—loan structures, investment options, and tax strategies—to set up debt recycling effectively. 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.