Debt Recycling Series Chapter 5: What Do You Need to Start Debt Recycling?

The key tools and considerations to set up debt recycling effectively

Mar 04, 2025

Debt recycling is one of many ways to grow investments while paying down a home loan, but it comes with complexity. Setting it up correctly is key—without the right loan structure, safety net, and tracking, the benefits may not be realised effectively.

So, what’s actually required to implement debt recycling properly? Let’s explore the essential components and considerations.

⚠️ 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. A Mortgage With The Right Setup

Debt recycling typically involves borrowing against home equity and investing those funds into income-generating assets. The Australian Tax Office (ATO) has clear guidelines that borrowed funds must be used specifically for investments that produce taxable income—mixing personal and investment use could disqualify tax benefits. One of the big mistakes people made when they DIY debt recycling is that they will use their existing loan, pay down a portion of it and the redraw the same amount all within the same account. In theory, the steps are correct, but they are missing the critical step of separating the personal loan and the investment loan, making it hard to track how much loan interest charged was for personal vs investment. So how do you avoid this mistake? By getting the right loan structure & features.

A loan structure could be:

Loan split – divide your mortgage into two or more separate parts, instead of having just one big loan. However, the total debt stays the same. This helps to separate the home loan (personal-use loan) from the debt-recycled loan (for investment) for easier tracking.
Equity release – A Home equity is the value of the home minus what is still owed on the mortgage. Equity release allows you to access this money by borrowing against it, which increases your loan balance, so your monthly repayments will go up. You get the cash as a lump sum, regular payments, or a line of credit.
Line of credit loan – Top up the debt as you go. This offers flexibility but requires careful management as its easy to borrow more.
Interest-only vs. Principal & Interest (P&I) – Interest-only loans may help cash flow in the short term (because the monthly repayment is smaller than P&I), but repayment planning is crucial as the monthly repayment would significantly go up when the interest only period ends. Lets say, you have fixed interest loan for 5 years, you still have the full debt by year 6 and now need to repay everything back in 25 years instead of 30, meaning the monthly repayment would now be higher.

A loan feature could be:

Flexible repayment options – Does the loan account offers the option for extra repayments? Not all loan accounts or banks offer flexible repayment options, such as making extra repayments without penalties. While many variable rate home loans allow unlimited additional repayments, fixed rate loans often impose restrictions or caps on extra payments.
Redraw facility – A redraw facility allows access to extra repayments, which is crucial for converting a home loan into an investment loan. For example, with a $500K home loan, if $100K is to be debt recycled, the loan is split into $400K and $100K. The $100K portion is fully paid off, then redrawn and used exclusively for investments. This process ensures clean separation of personal and investment debt, making tax deductibility possible. Without a split, tracking investment debt can be difficult. Consulting a tax accountant can help ensure compliance.
Loan portability – Allows transferring the mortgage without closing the loan, saving costs.
Offset account – An offset account is like a regular bank account, but instead of earning interest, it helps reduce the interest you pay on your mortgage. How it works:
- Imagine you have a $500K mortgage and $20K in your offset account.
- Instead of paying interest on the full $500K, you only pay interest on $480K ($500K - $20K).
- The more money you keep in your offset account, the less interest you pay, which can help you pay off your loan faster.

⚠️ Important Note:

Splitting a home loan doesn’t change repayments. This is because the total debt on the house is still the same, therefore the repayment amount stays the same. The repayments just get divided proportionally to the loan split and each portion may have different interest rates (if the bank gives different rates).
When you access home equity, you’re borrowing more money, which adds to your total loan balance and increasing the monthly repayments.
Loan repayments are based on the total borrowed amount, regardless of how much is in an offset account—offset accounts reduce interest costs but do not change the required monthly repayments. In simple terms, while required monthly repayments stay the same, a bigger portion of your monthly repayments goes towards paying down the principal instead of pay interest if you have cash in the offset account.

2. An Income-Producing Investment

Debt recycling typically involves investing in assets that generate income. The ATO requires that borrowed funds be used specifically for investments that produce assessable income, such as:

✅ Shares and ETFs – Dividends can help offset loan interest.
✅ Investment properties – Rental income qualifies as assessable income.
✅ Managed funds – Some funds distribute regular income.
✅ Business investments – If structured correctly, business income may qualify.

⚠️ Important Tax Considerations:

You cannot debt recycle with just any investment according to the Australian Tax Office (ATO). To qualify for tax deductions on the loan interest, the ATO requires that the borrowed funds are used specifically for investments that generate assessable income.

Borrowing for vacant land, collectibles (e.g., art, watches, cars), or speculative assets (e.g., crypto without staking or dividends) does not qualify for debt recycling tax benefits.
Investment loans must have a clear purpose—mixing personal and investment use can complicate tax deductions.
Choose investments that suits your goal and risk profile and consult with your tax advisor to check eligibility!

3. A Solid Safety Net

Because debt recycling involves borrowing to invest, it’s important to have financial safeguards in place.

A Stable & Reliable Income
Loan repayments remain a fixed obligation, even if investment returns fluctuate. If income is unstable, this could increase financial stress.
An Emergency Fund
An emergency fund can help manage unexpected financial challenges. The right amount varies based on:
🔹 Employment stability – How quickly could new job be found?
🔹 Dependents – A single person vs. a family has different financial needs.
🔹 Other support – Is there a second household income to rely on?
Cash Flow Planning
Loan repayments must continue even if investment returns are lower than expected. It’s important to ensure cash flow can support ongoing commitments.
Income Protection Insurance
Since debt recycling depends on steady income, some people choose income protection insurance. Income protection insurance typically covers 70–85% of their income if you’re unable to work due to injury or unforeseen circumstances for prolonged period of time. Since most policies have a 30-90 day waiting period, they'll need to rely on their emergency fund initially. But it prevents loan defaults or premature investment sales during extended work absences.

4. Financial Tracking Tools

The ATO requires clear records to ensure that borrowed funds are used for investments, not personal expenses.

Demonstrating a Clear Borrowing Purpose

📌 Bank statements showing redrawn funds were used for investment purchases.
📌 Brokerage records or property settlement documents matching loan withdrawals.
📌 Separate accounts for investment and personal funds.

Tracking Investment Income

✅ Dividends from shares or ETFs – Reflected in tax summaries.
✅ Rental income and property expenses – Documents from property managers.
✅ Interest income from bonds or term deposits – Statements from financial institutions.

Keeping detailed records can help simplify tax reporting and ensure compliance with ATO guidelines.

5. Professional Advice

Debt recycling involves tax rules, loan structures, and investment risks—which is why many people seek professional advice before implementing it.

Financial Adviser
- Helps tailor the strategy to personal financial goals.
- Assesses whether debt recycling is appropriate for individual circumstances.
Mortgage Broker
- Assists with loan structuring, including splits and redraw facilities.
- Compares lenders to find competitive investment loan rates.
Tax Accountant
- Ensures compliance with ATO requirements.
- Tracks tax-deductible interest and reporting obligations.

⚠️ Debt recycling is a complex strategy with financial risks—consulting professionals helps ensure it is structured correctly and aligns with individual goals.

Final Thoughts

Debt recycling is a strategy that combines paying down a mortgage with investing for the future, but it’s not a one-size-fits-all approach. While it has the potential to increase wealth over time, it also comes with risks, such as market fluctuations, interest rate changes, and the need for disciplined cash flow management.

The right setup—a structured loan, income-generating investments, a financial safety net, and proper record-keeping—can make debt recycling more effective. But without the right foundations, it could become more stressful than beneficial.

For those considering debt recycling, speaking with a licensed financial adviser, tax accountant, and mortgage broker can provide clarity on whether it aligns with their financial situation and goals.

So, What’s Next?

Next, we’ll explore different ways to structure debt recycling—loan splits, equity release, and lines of credit. Each method has its own pros and cons, and working with qualified professionals is key to setting it up correctly. 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.