Investor lending in Australia is surging, with more than $130 billion borrowed in the last year alone. One reason driving the surge is “debt recycling”, where people pay down the debt on the house they live in and then borrow the same amount to invest.
The strategy is a tax-friendly fast-track into property investing because it shifts the non-deductible debt in a person’s principal place of residence (POPR) to tax-deductible investment debt.
Australia’s tax rules mean that if re-borrowed funds are used to acquire an income-producing asset, such as an investment property, the interest on the investment portion of the borrowing can be deductible.
The pros of Debt Recycling
- Tax efficiency created as a result of a higher share of deductible interest
- The non-deductible PPOR debt is paid down faster
- Earlier entry into property investing than would otherwise have been the case
- Existing equity is used for borrowing rather than having to find new savings.
The cons
- A higher level of leverage can increase your exposure to interest rate rises
- Potential for over-claiming deductibility if debt is not structured correctly
- Negative equity if property prices fall
- Australia’s tax rules concerning property are coming under increasing scrutiny, and the preferential treatment of recycled debt may change in the future.
A word of caution
If you’re thinking about using debt recycling as a means of getting into property investing, be sure to get advice and assistance on structuring your loan correctly. Clearly identified loan splits help to avoid contamination of deductible and non-deductible interest.