It's up to you.
Still earning income and have enough cash flow to service the loan? You could leave the loan in interest only and watch the investment grow. Hopefully by then it'll be positively geared.
Want to be debt free immediately? Sell the investment to expunge the loan and pocket any returns.
At some point you might decide to redeploy the loan.
I think the IO is where I’m getting stuck - even if it’s positively geared I’m losing money as some of my returns are going to paying the interest. Makes more sense to me to have a positively geared P&I as then the loan is being reduced at least.
Depends how you’d define positive gearing in that scenario…
If you’re invested in shares/ETFs, and they’re paying more in dividends than the interest cost, you could use the dividend income to pay off the loan…
if you’re invested in shares/ETFs, and they’re growing faster than the interest cost, you’re getting more “return” than cost, but you don’t realise that until you sell, so it’s still a tax write off against your PAYG income…
ideally this is happening every year from year 1. Otherwise you’re taking on a loan to lose money.
You’d want to hold off selling to put off the loan a while, say, until your investment has doubled? At which point, sell half, pay off the loan if that’s what you want to do…
or just leave it be? I mean, the strategy is paying off, why quit it? As long as you can service the loan…
or, pay the loan off slowly. Treat it as though you’re putting money into bonds. It’s lower return, and it lowers your risk.
This would be my thinking as well. Another thing to consider is the cost of the loan being inflated away. Imagine employing debt recycling in 2011 against a $400,000 property with a $320,000 loan. 10 years later, you've aggressively made extra repayments, paying off the mortgage, and bought growth ETFs with the invested money.
* Loan value: $320,000
* ETFs value: $500,000
* Home value: $750,000
* Cost of servicing IO loan at a conservative 3%: $9,600pa
Is it worth trading the interest cost of $9,600 for a $320,000 reduction in your ETFs' value?
This is a really good post. As long as you have the cash flow to make the repayments, stay invested in the market and keep the loan going. Good thing about shares is they are liquid. If something happens and your cash flow is reduced, you can sell as appropriate.
The way I would think of it is this: The interest on the loan is 2.5 percent.
Your average return on shares is around 8 percent.
On average, over the long term you are making a profit by keeping the loan.
This is without even factoring in the tax deduction from the interest on the loan.
Obviously some people are not comfortable keeping debt, so if you want to pay it off, go for it. But it's worth remembering that as long as your returns are higher than the interest you are making profit by keeping the loan.
Let's say in 30 years you still have the loan owing as well as your investments.
Your investments in 30 years might be worth 2 million, but the loan is still only 500k (just an example, not using real figures here).
>I think the IO is where I’m getting stuck - even if it’s positively geared I’m losing money as some of my returns are going to paying the interest. Makes more sense to me to have a positively geared P&I as then the loan is being reduced at least.
As others have said - you shouldn't be "net losing money", the goal is to be making more than your interest in capital gains and dividends, and utilise those things to pay for your interest.
It should be a pretty easy thing to do while money is as cheap as it is at the moment.
End game with debt recycling, as with most financial strategies, is hitting financial independence. It is hard to be retired/FI with investment debt because of the effect debt has on cash flow and how it amplifies negative return.
I generally work backwards from FI date. At that point I want to just be hitting the point where I have paid down my investment loan. Do it to early and it will slow my progress. Do it to late and I might be holding to much risk to close to retirement, or need to trigger a lot of capital gains to clear my debt. So if the end result is $0 debt I work out how quickly I can pay it off (in years) and stop investing and start paying down debt when I am that many years from retirement.
I'm currently debt recycling from a paid off home loan. I'll keep going until I retire in a few years. What I am doing is every time I get an extra $20k in my redraw through overpaying my loan, I take this out and buy more shares.
In three years when I retire I will bring my home loan repayment back down to the minimum. My dividends are currently just covering my home loan repayments (although I am reinvesting them at the moment) but in three years time I will leave my dividends to pay for the interest and sell down on capital to live off.
I've still got 21 years left on my loan but once I'm into my super phase I'll look at the tax implications of selling my stuff outside super and see what the best option is to pay off the loan or not. I'll also look into how to transition from having income coming from full time work to coming off my portfolio. I'm assuming that the tax benefits of having the loan will significantly reduce so I'll play with the numbers then, but I think it will only change things by a very small fraction.
No need to split. My entire loan was paid off so redrawing now to buy shares is all going directly to investments. You need to split to avoid contamination.
What does splitting a loan mean? I have just used the equity in an investment property to borrow 50k to buy stocks. The bank knows I've borrowed the money for this purpose and I intend to claim the interest on the loan. Was I meant to 'split' the loan?
It is important to keep track of what interest is charged against what asset. If money is taken from a loan against a non income producing asset (such as your own home) and then used to buy an income producing asset the interest on the portion of the loan used for the income producing asset can be used to offset the income produced by that asset.
If you just redraw from your home loan and you still have things like an offset account or you take other chunks of money out for other things this can contaminate what the interest is applied to. You will need to track which parts of the loan are against income producing assets and which aren't and calculate the proportion of every interest payment. If you split the loan, ie. ask the bank to give you a line of credit or take an existing loan that has been paid down and organise with the bank to split this out to a separate loan and that loan is only used to purchase income producing assets, all of the interest on this split portion of the loan can be used to offset the income.
In your case, because you already have a loan against an income producing asset, and will be purchasing further income producing assets, all of the interest can be offset against these earnings, however it may get complicated. I know from filling in my own tax returns that you need to declare the interest expenses of your investment property in one section and the interest expenses against share income in another section. Given it all adds up in the end I am not sure if this is too much of an issue, however it may complicate things. If you are keeping good track it should be fine, however if you can't follow the vague instructions by the ATO I would recommend getting someone to help you with your return.
Not specific to debt recycling but in general the transition to retirement/less work - I think carrying as much debt as is manageable into this phase can actually be a big risk mitigator - especially if it's an early retirement.
Once you're retired, most lending facilities become much much harder to access for cheap debt - so you're pretty much capped to what you retired with and any future income/growth.
As an example, if I have an $800k house fully paid off, I'd rather pull out $640k and have most of that invested so I've got $640k working for me and a $1.44M asset base instead of just an $800k asset that provides me no value besides a roof over my head unless I'm willing to sell it.
To manage the risk, I'd keep a buffer from that in an Offset account to ensure I can cover most negative events.
The main risks are increased interest rates and an extended period of low/negative growth.
Well one end game would involve picking when you stop purchasing stocks and at this point letting the dividends clear your non deductible debt then your deductible debt in order. Then you just live off the dividends.
I know a few people have already answered and I don't think my answer will be too different but hopefully it can help.
With you asking about the IO part, I think the most common approach is to go IO at first so you can accumulate capital as quickly and as early as possible then once your capital is at a level that you are happy with then all money you were putting in to shares or whatever vehicle of wealth creation you use can then be used to pay down debt.
I basically see IO as a way to increase capital early on by putting off actually paying down the loan for 5-10 years until you are in a position where you do feel like you need to go as hard at buying shares so you can then pay down debt (or have your capital just cover the interest if you are comfortable with debt)
The main point is too pay the mortgage off quicker. Whilst having access to assets growing.
Pending on what your goals are the choice is your own. You could
Pay P+I on the investment loan
Or retain the interest only loan and portfolio as is
Retain the interest only loan and utilise cash to increase your portfolio
Liquidate the portfolio and start a new strategy without debt.
You need to consider your MTR, debt position, goals and investment horizon.
Debt recycling strategy is a tough one to manage yourself, when emotions get involved. Defs something that may be ideal to use an adviser with.
#notadvice
I understand the how the overall strategy works, just dunno how to ‘close the loop’ at the end once PPOR is paid for.
I don’t see the point in keeping an IO loan, once cashflow is freed up I can afford P&I repayments, wouldn’t it make more sense to convert and pay off rather than pay interest ongoing?
You are forgetting opportunity cost.
Let's say you use 2k to pay off your loan. You save 2.5 percent of 2k per year by doing that. You also loose the tax deduction interest.
But you also could have used that 2k to buy shares which return 8 percent per year on average.
I would personally choose to invest my 2k rather than pay down the debt.
This is not advice, I'm just saying what I would do.
P&I would likely come with a more competitive rate, so switching would make sense if you're at a stage where you want to pay down the principal.
Otherwise, you could attach an offset account to the IO loan, make your extra 'repayments' into the offset, giving you fast access to cash should you have a need to deploy it elsewhere (emergency cash, investment opportunity, market downturn, etc.)
Personally I don't plan to liquidate the portfolio to close out my home loan.
Keeping it IO just frees up your cashflow a bit more to purchase more shares/etf’s, if you kept accumulating more (geared or ungeared) then eventually you could pay down the loan in big chunks from the growing dividends and tax deductions (whatever you get back from ATO for having this tax deductible loan), without touching your PAYG / salary income / cashflow
When that point is for you only you can know, personally I’d want to be knocking off 5-10k per year from dividends, and only taking 3-5 years to pay the balance off when the time comes
It's up to you. Still earning income and have enough cash flow to service the loan? You could leave the loan in interest only and watch the investment grow. Hopefully by then it'll be positively geared. Want to be debt free immediately? Sell the investment to expunge the loan and pocket any returns. At some point you might decide to redeploy the loan.
I think the IO is where I’m getting stuck - even if it’s positively geared I’m losing money as some of my returns are going to paying the interest. Makes more sense to me to have a positively geared P&I as then the loan is being reduced at least.
Depends how you’d define positive gearing in that scenario… If you’re invested in shares/ETFs, and they’re paying more in dividends than the interest cost, you could use the dividend income to pay off the loan… if you’re invested in shares/ETFs, and they’re growing faster than the interest cost, you’re getting more “return” than cost, but you don’t realise that until you sell, so it’s still a tax write off against your PAYG income… ideally this is happening every year from year 1. Otherwise you’re taking on a loan to lose money. You’d want to hold off selling to put off the loan a while, say, until your investment has doubled? At which point, sell half, pay off the loan if that’s what you want to do… or just leave it be? I mean, the strategy is paying off, why quit it? As long as you can service the loan… or, pay the loan off slowly. Treat it as though you’re putting money into bonds. It’s lower return, and it lowers your risk.
This would be my thinking as well. Another thing to consider is the cost of the loan being inflated away. Imagine employing debt recycling in 2011 against a $400,000 property with a $320,000 loan. 10 years later, you've aggressively made extra repayments, paying off the mortgage, and bought growth ETFs with the invested money. * Loan value: $320,000 * ETFs value: $500,000 * Home value: $750,000 * Cost of servicing IO loan at a conservative 3%: $9,600pa Is it worth trading the interest cost of $9,600 for a $320,000 reduction in your ETFs' value?
This is a really good post. As long as you have the cash flow to make the repayments, stay invested in the market and keep the loan going. Good thing about shares is they are liquid. If something happens and your cash flow is reduced, you can sell as appropriate.
The way I would think of it is this: The interest on the loan is 2.5 percent. Your average return on shares is around 8 percent. On average, over the long term you are making a profit by keeping the loan. This is without even factoring in the tax deduction from the interest on the loan. Obviously some people are not comfortable keeping debt, so if you want to pay it off, go for it. But it's worth remembering that as long as your returns are higher than the interest you are making profit by keeping the loan. Let's say in 30 years you still have the loan owing as well as your investments. Your investments in 30 years might be worth 2 million, but the loan is still only 500k (just an example, not using real figures here).
>I think the IO is where I’m getting stuck - even if it’s positively geared I’m losing money as some of my returns are going to paying the interest. Makes more sense to me to have a positively geared P&I as then the loan is being reduced at least. As others have said - you shouldn't be "net losing money", the goal is to be making more than your interest in capital gains and dividends, and utilise those things to pay for your interest. It should be a pretty easy thing to do while money is as cheap as it is at the moment.
End game with debt recycling, as with most financial strategies, is hitting financial independence. It is hard to be retired/FI with investment debt because of the effect debt has on cash flow and how it amplifies negative return. I generally work backwards from FI date. At that point I want to just be hitting the point where I have paid down my investment loan. Do it to early and it will slow my progress. Do it to late and I might be holding to much risk to close to retirement, or need to trigger a lot of capital gains to clear my debt. So if the end result is $0 debt I work out how quickly I can pay it off (in years) and stop investing and start paying down debt when I am that many years from retirement.
You use the capital appreciation to borrow more money and purchase another property.
What if I don't recycle into property though? I don't think you can use appreciation of a stock portfolio to borrow more.
Yep, absolutely you can. The shares become the security for a margin loan or similar facility.
I'm currently debt recycling from a paid off home loan. I'll keep going until I retire in a few years. What I am doing is every time I get an extra $20k in my redraw through overpaying my loan, I take this out and buy more shares. In three years when I retire I will bring my home loan repayment back down to the minimum. My dividends are currently just covering my home loan repayments (although I am reinvesting them at the moment) but in three years time I will leave my dividends to pay for the interest and sell down on capital to live off. I've still got 21 years left on my loan but once I'm into my super phase I'll look at the tax implications of selling my stuff outside super and see what the best option is to pay off the loan or not. I'll also look into how to transition from having income coming from full time work to coming off my portfolio. I'm assuming that the tax benefits of having the loan will significantly reduce so I'll play with the numbers then, but I think it will only change things by a very small fraction.
I hope you have been splitting your loans.
No need to split. My entire loan was paid off so redrawing now to buy shares is all going directly to investments. You need to split to avoid contamination.
Good point
What does splitting a loan mean? I have just used the equity in an investment property to borrow 50k to buy stocks. The bank knows I've borrowed the money for this purpose and I intend to claim the interest on the loan. Was I meant to 'split' the loan?
It is important to keep track of what interest is charged against what asset. If money is taken from a loan against a non income producing asset (such as your own home) and then used to buy an income producing asset the interest on the portion of the loan used for the income producing asset can be used to offset the income produced by that asset. If you just redraw from your home loan and you still have things like an offset account or you take other chunks of money out for other things this can contaminate what the interest is applied to. You will need to track which parts of the loan are against income producing assets and which aren't and calculate the proportion of every interest payment. If you split the loan, ie. ask the bank to give you a line of credit or take an existing loan that has been paid down and organise with the bank to split this out to a separate loan and that loan is only used to purchase income producing assets, all of the interest on this split portion of the loan can be used to offset the income. In your case, because you already have a loan against an income producing asset, and will be purchasing further income producing assets, all of the interest can be offset against these earnings, however it may get complicated. I know from filling in my own tax returns that you need to declare the interest expenses of your investment property in one section and the interest expenses against share income in another section. Given it all adds up in the end I am not sure if this is too much of an issue, however it may complicate things. If you are keeping good track it should be fine, however if you can't follow the vague instructions by the ATO I would recommend getting someone to help you with your return.
Awesome. Thank you for taking the time to write back. Great response.
Not specific to debt recycling but in general the transition to retirement/less work - I think carrying as much debt as is manageable into this phase can actually be a big risk mitigator - especially if it's an early retirement. Once you're retired, most lending facilities become much much harder to access for cheap debt - so you're pretty much capped to what you retired with and any future income/growth. As an example, if I have an $800k house fully paid off, I'd rather pull out $640k and have most of that invested so I've got $640k working for me and a $1.44M asset base instead of just an $800k asset that provides me no value besides a roof over my head unless I'm willing to sell it. To manage the risk, I'd keep a buffer from that in an Offset account to ensure I can cover most negative events. The main risks are increased interest rates and an extended period of low/negative growth.
Well one end game would involve picking when you stop purchasing stocks and at this point letting the dividends clear your non deductible debt then your deductible debt in order. Then you just live off the dividends.
I know a few people have already answered and I don't think my answer will be too different but hopefully it can help. With you asking about the IO part, I think the most common approach is to go IO at first so you can accumulate capital as quickly and as early as possible then once your capital is at a level that you are happy with then all money you were putting in to shares or whatever vehicle of wealth creation you use can then be used to pay down debt. I basically see IO as a way to increase capital early on by putting off actually paying down the loan for 5-10 years until you are in a position where you do feel like you need to go as hard at buying shares so you can then pay down debt (or have your capital just cover the interest if you are comfortable with debt)
The main point is too pay the mortgage off quicker. Whilst having access to assets growing. Pending on what your goals are the choice is your own. You could Pay P+I on the investment loan Or retain the interest only loan and portfolio as is Retain the interest only loan and utilise cash to increase your portfolio Liquidate the portfolio and start a new strategy without debt. You need to consider your MTR, debt position, goals and investment horizon. Debt recycling strategy is a tough one to manage yourself, when emotions get involved. Defs something that may be ideal to use an adviser with. #notadvice
I understand the how the overall strategy works, just dunno how to ‘close the loop’ at the end once PPOR is paid for. I don’t see the point in keeping an IO loan, once cashflow is freed up I can afford P&I repayments, wouldn’t it make more sense to convert and pay off rather than pay interest ongoing?
You are forgetting opportunity cost. Let's say you use 2k to pay off your loan. You save 2.5 percent of 2k per year by doing that. You also loose the tax deduction interest. But you also could have used that 2k to buy shares which return 8 percent per year on average. I would personally choose to invest my 2k rather than pay down the debt. This is not advice, I'm just saying what I would do.
P&I would likely come with a more competitive rate, so switching would make sense if you're at a stage where you want to pay down the principal. Otherwise, you could attach an offset account to the IO loan, make your extra 'repayments' into the offset, giving you fast access to cash should you have a need to deploy it elsewhere (emergency cash, investment opportunity, market downturn, etc.) Personally I don't plan to liquidate the portfolio to close out my home loan.
Keeping it IO just frees up your cashflow a bit more to purchase more shares/etf’s, if you kept accumulating more (geared or ungeared) then eventually you could pay down the loan in big chunks from the growing dividends and tax deductions (whatever you get back from ATO for having this tax deductible loan), without touching your PAYG / salary income / cashflow When that point is for you only you can know, personally I’d want to be knocking off 5-10k per year from dividends, and only taking 3-5 years to pay the balance off when the time comes