A debt recycling strategy is a way to pay off your family home in record time using investments to accelerate the process. It creates an opportunity to build wealth, pay off your mortgage and become financially free. but using debt (risky) to buy shares (risky) to pay off your home sounds…. Risky. Right? Well, maybe not.
Let me connect the dots on my Debt Recycling strategy. From Peter Thornhill’s theory to Charlie Munger via Noel Whittaker, Terry Waugh, and back again. This includes answering what is debt recycling, the benefits, and the end game.
Please continue reading or feel free to jump ahead.
Debt Recycling Strategy to Financial Independence
The definition of financial independence can vary for most people. Some allocate a fire number, an amount they need to retire with. But for many people, myself included, I don’t have a specific number. The goal for many people is very simple: Pay off the mortgage and stop paying interest. This can be difficult when you have a family and children, so it does seem like a far-off dream.
Peter Thornhills debt recycling strategy can help make that dream a reality. The debt recycling strategy can help you pay off your mortgage while building a portfolio of income-producing shares. The dividends from those shares will help you pay that mortgage off in record time as discussed by Peter Thornhill in various interviews.
Please read the Motivated Money Monster Ultimate Guide about Peter Thornhill and his rules, strategies and philosophies on finance. He believes that “Financial Independence is easy to attain” and anyone can do it too.
Unfortunately, the strategy sounds complicated and the details can hold you back. Such as which bank will let you debt recycle. And what happens with this huge debt you create after your mortgage is gone? Because you still need to pay that back. Over the last two years, as I studied and re-read various books, the strategy made more sense. I connected a few dots and discovered the debt recycling endgame.
But let me start with a definition of debt recycling.
What is Debt Recycling?
Debt recycling is the process of “recycling” or replacing mortgage debt with investment debt. This also replaces your non-tax deductible debt (bad) with tax-deductible debt (good). It has also been called “Negative Gearing with Shares”.
The process of debt recycling sounds simple. With your existing home loan, use equity from that loan to invest in an ETF or LIC. These shares will produce dividends that go into your bank offset account. As you pay down your mortgage debt, you use more equity from your home loan and buy more shares.
The debt recycling process transfers the debt from your home (non-tax deductible) to your share portfolio (tax-deductible). But the scary part of debt recycling is we use debt to buy shares. And that debt should be an interest-only loan.
Using debt to pay off debt doesn’t sound right. And most people don’t like the sound of building debt, they want to get out of debt, not get deeper into debt. But that is where we use another key strategy to help with that.
Peter Thornhill’s Two Rules For Wealth Creation
Peter Thornhill has two simple rules for wealth creation and investing.
- Spend less than you earn
- Borrow less than you can afford.
Peter believes that if you can just do this alone ”you’re already on your way to financial security.” If you are using debt, you want to be able to sleep at night. Peter’s rules are sensible and should be followed if you are looking to use the debt recycling strategy.
But why use debt at all? Why not just slowly chip away at an indexed fund, and get rich super-slow? This is a fantastic strategy for most people. The problem is we’re not all in our early twenties with spare cash to invest for years and years. If you are happy to wait, that is great.
But some older folk (like myself) could use debt to shortcut the compounding waiting game. Or anyone that wants to use their home equity and are comfortable with debt. Because if you can unlock 100k in equity to start debt recycling, you can shortcut the waiting game,
This is where I defer to Charlie Munger for his take on getting to that first 100k.
The First 100k is a B***h!
Charlie Munger said it best. But getting to 100k can take years, depending on your salary and savings rate. A Debt recycling strategy can be used as a shortcut to get to 100k faster if you have the equity to do so. This means you can really start compounding earlier and get to your financial independence goal sooner.
But the next question is, if you borrow money you need to pay interest. Even if it is a lower interest rate, you could be losing money in the beginning. And what if interest rates go up? You could get into trouble. And that is where you defer back to Peter Thornhills golden rules
- Spend less than you earn
- Borrow less than you can afford.
Peter Thornhill put it another way that makes more sense to most people. He is negatively gearing his shares. Most people use negative gearing for property, but why not shares? why is losing money on a property month after month fine, but shares are not?
This is where we look at the impact of interest rates on your debt recycling strategy.
Debt Recycling with Increased Interest Rates
Terry Waugh is a solicitor, chartered tax advisor, mortgage broker and debt recycling specialist. He also hosts the Structuring Podcast. In a recent episode (episode 88), he discussed high-interest rates while debt recycling.
If interest rates are high (say 6%), and investment returns are lower at 4%, you are not making a profit. And that extra money you are losing could be used to pay off your non-deductible debt. This is not an ideal scenario, which Terry calls “debt recycling in reverse”.
Terry believes that “you should always debt recycle because you are gaining a tax advantage you otherwise would not get.” And hopefully, that capital growth will translate into higher returns on the income side. So that initial loss will become a long-term positive gain.
And maybe, we need to think about our debt-recycling strategy, through a different negative gearing mindset via Noel Whittaker.
Noel Whittaker is a personal finance legend and his book Motivated Money is a must-read. He believes that any claim that negative gearing is a great way to save tax “is nonsense”. He gives a fantastic example that applies here.
If an investor borrowed $100,000 to buy shares, where income from the asset is $4,000 and the interest is $6,000 a year. The tax savings for that amount would be $900 in the top tax bracket.
Noel looks at negative gearing from a different perspective. He doesn’t see negative gearing as a way to pay less tax. It is a way to attain assets and build wealth. It’s also a way to control an asset worth $100,000 for a total cost of $27 a week if they are in the 32.5% tax bracket, $26 a week if they are in the 37% tax bracket and $21 a week if they are in the top tax bracket.
That is why a debt recycling strategy that will negatively gear your share portfolio is a fantastic path to financial independence. You can start big and grow slowly from there. But what happens next? If you transfer your mortgage debt to another debt, it is still debt that needs to be paid. So when should you pay down that debt? What is the debt recycling end game?
Debt Recycling Endgame
The main point of a debt recycling strategy is to pay down your non-deductible debt. That means your mortgage should be a Principal and Interest Loan (PI) and your Investment Loan (for your shares) should be Interest Only (IO). This will allow you to focus all of your payments on the PI non-deductible debt.
The part that was always confusing to me was, what happens with this debt you have recycled. When should I pay that off? If your mortgage is paid down to nothing, do you want to then focus on paying down your investment loan? Or do you want to keep investing and compounding your investments? This piece of the puzzle was never really explained anywhere.
That is when I stumbled upon a Case study in Noel Whittaker’s Making Money Made Easy.
The Case study has a couple that borrows $400,000 to invest in blue chip share trusts at age 40. At age 50, their home is paid off and they focus those payments on Superannuation. At age 65, they retire with $4.8 million in share trusts and over $1 Million in Super. Once retired, they can withdraw $400,000 tax-free from their super to pay off the debt.
And that was when it all made sense.
As long as the investment loans can be extended, I should continue to invest. And if all else fails, when I retire I should have a decent-sized superannuation amount and a healthy investment portfolio. And like the example above, the debt can be paid down with Super.
Final Thoughts
The debt recycling strategy is a new thing. And it makes sense as a complete financial independence solution for anyone with equity in their home loan. As Peter Thornhill says, it will give you the “Double Whammy” of paying off your home loan while building a share portfolio that will generate passive income.
I have studied Debt Recycling for many years since I first discovered it on the Aussie Firebug podcast. I knew this strategy would be perfect for my Financial Independence goals, but it never made complete sense. In that time, I have read and re-read books, articles, and comments on various posts. The concept sunk in (very slowly) as my Financial IQ increased over the last few years.
I have studied the debt recycling strategy, put together my case for it, and I am putting my theory into practice. I’ll document that as a step-by-step guide once implemented. In the meantime, let me know if you have any questions and I’ll try my best to answer them.
I hope you enjoyed this post, let me know what you think
M. Moneyman
