Debt recycling: how the loan has to be set up

What is debt recycling?

Debt recycling is paying down your home loan with spare cash, then borrowing the same amount back in a separate loan split and investing it. What you owe stays about the same. What changes is what the debt is for: less of it paid for the home you live in, more of it borrowed to invest.

Debt recycling isn't a loan product in itself. At the bank it's a loan split: one home loan divided into separate accounts, each with its own balance and its own purpose. Debt recycling is the name for what you do with those splits.

People do it because interest on money borrowed to earn income can be tax deductible, and the ATO judges that by what the borrowed money is used for [1]. Whether that applies to you is your accountant's call (part 9).

A debt recycling example: five years, in numbers

Here's a debt recycling example, an illustration and not a client file: a $600,000 home loan, $20,000 of spare cash each year, and an illustrative 6.00% interest rate on both splits. To keep the numbers clean, it leaves out the regular repayments, which would shrink the home part further [4].

After five rounds you still owe $600,000, and the interest bill is still about $36,000 a year at 6.00%. But $100,000 of it is now money borrowed to invest, and you hold investments that cost $100,000, worth whatever the market says on the day.

What this means for you: debt recycling doesn't make the loan cheaper. The interest bill is the same. What changes is what the money paid for, and whether part of that interest is deductible, which is your accountant's question, not ours.

Debt recycling or paying off your mortgage faster?

Debt recycling and paying off your mortgage faster start the same way: spare cash goes into the home loan. The difference is the second step. Pay it down and stop, and your debt falls. Recycle it, and you borrow it back to invest, so your debt stays where it was.

On the same illustration, five years of paying down leaves $500,000 owing and about $30,000 a year of interest at 6.00%. Five years of recycling leaves $600,000 owing, about $36,000 a year of interest, and $100,000 of investments [4].

What this means for you: the question isn't which one is clever. It's whether you'd rather owe $100,000 less, or owe the same and own $100,000 of investments that can rise or fall. That choice is yours to make with a licensed financial adviser; how the loan has to be set up for either is ours.

Is debt recycling worth it?

Whether debt recycling is worth it depends on things like a steady income, regular spare cash, how long you could stay invested, and how you'd cope with investments falling as well as rising. It turns money that would have paid down the home loan into an investment bought with borrowed money, so you take on investment risk you otherwise wouldn't.

Whether it's worth it for you turns on things no lender decides: your tax position, what you invest in and how long you hold. Those are questions for your accountant and a licensed financial adviser. The lending side decides something narrower but just as important: whether the structure is clean enough for the strategy to work at all (part 11).

Is debt recycling legal, and what does the ATO say?

Yes, debt recycling is legal in Australia. It rests on a long-standing ATO ruling, TR 2000/2, on interest on money drawn from redraw facilities and lines of credit [1].

The ruling says three things that matter for the loan. Money redrawn from a loan is a new borrowing: in the ATO's words, "Where a loan facility allows for redraws of extra repayments, we consider those redraws constitute new borrowings of funds" [1]. Whether the interest is deductible follows what that borrowed money is used for, not which loan it came from. And where one account is used for both personal and investment purposes, the interest has to be divided between them [1].

What this means for you: the ATO judges each dollar by where it went. That's why the loan structure isn't a detail of debt recycling. It's the part that decides whether the strategy holds up.

Is debt recycling tax deductible?

Whether debt recycling's interest is tax deductible for you is your accountant's call, not a broker's. The ruling sets the principle, that interest follows the use of the money [1]. How it applies to your income, your investments and your records is personal tax advice.

What a broker can do is make the loan easy to explain: one split, one purpose, every draw going straight to an investment, and statements that show it. Take that structure to your accountant before the first round, not after.

Debt recycling isn't the same thing as negative gearing. Debt recycling is about what the borrowed money is used for. Negative gearing is a tax term for an investment whose costs are more than its income. One doesn't need the other, and how either applies to you is a question for your accountant.

How do you set up a debt recycling loan?

A debt recycling loan is set up as at least two separate splits on the same home loan: the home part, and an investment split used only for investing. Each split is its own loan account, with its own balance and statements, so the purpose of every dollar in it is clear.

The money's path matters as much as the splits. Money drawn from the investment split should go straight to the investment, such as a share trading account, not through your everyday account. Keep the record of every draw and what it bought (part 24).

Which of these set-ups a lender offers, and on what terms, differs, and guides disagree on which is best. We don't pick one for every reader. The requirement is the same in each: separate, and traceable.

The one mistake that undoes debt recycling

The mistake that undoes debt recycling is a single draw from the investment split for something personal, such as a car or a holiday. That one draw mixes the purpose of the split. From then on, the interest has to be divided between the investment and the personal use [1], and the records get harder to defend.

The same thing happens when money for the investment goes through your everyday account first, where it mixes with your pay and your bills.

What this means for you: the mistake is avoidable if the structure makes it hard to do by accident. No everyday payments from the investment split, no card linked to it, and every draw going to one place only.

Offset or redraw: where should the spare cash sit?

For debt recycling, spare cash held in an offset account still has to be paid into the home part before it can be recycled. Money in an offset lowers the interest on the split it's linked to, but it's still your savings, not a repayment, so taking it out isn't a redraw.

So a round goes: savings built up in the offset, then paid into the home part, then the same amount drawn from the investment split. On the illustration, $20,000 held in an offset against the home part at 6.00% saves about $1,200 of interest in a year, the same as paying it off. The difference is that money paid off can be borrowed back to invest [4].

Guides disagree on the exact path, and lenders' systems differ, so we don't set one bank's routine as the rule. The test is always the same: could you show, from the statements, where each dollar went?

Which banks allow debt recycling?

Debt recycling isn't a bank product, so the real question about which banks allow it is which loans can run it cleanly: separate splits, redraw on each one, a split that stays open at zero, and an offset on the home part (part 13). How well each lender handles those four things is what differs.

Some banks talk about it openly. NAB, for one, publishes its own guide explaining debt recycling [6].

One lender rule we've read in full: Firstmac doesn't allow splits or redraws on construction loans [5]. If you're building, the strategy waits until the build is finished and the loan becomes an ordinary home loan. See construction loans.

We haven't published a lender-by-lender table yet. Money Brain publishes a lender's rule only once we've read it in that lender's own documents and dated it, so for now we answer this one on the loan you'd actually use.

Do you need to refinance to start debt recycling?

You don't always need to refinance to start debt recycling. If your current lender can split your loan, and the splits have the features in part 13, the change may be possible on the loan you have.

If it can't, a refinance to a lender whose loan can is the first step. A refinance is a new application: the new lender assesses your income, your debts and the loan at its own test rate (part 17). On a fixed rate, ask what leaving before it ends would cost. See refinancing your home loan.

Interest only or principal and interest on the investment split?

The investment split can be interest only or principal and interest, where the lender offers both for it. On interest only, the balance stays put and you pay only the interest. On principal and interest, every repayment also pays some of it off.

On a $100,000 investment split at an illustrative 6.00%, interest only is $500 a month, and principal and interest over 30 years is about $600 a month [4]. The extra $100 or so a month pays down the borrowing that's for investing, not the home part. Whether that trade suits you is for your accountant and adviser; what each lender allows on the split is ours. See interest only or principal and interest.

Does debt recycling affect how much you can borrow?

Debt recycling on its own doesn't change how much you owe: if the total loan stays the same, the split changes what each part is for, not the size of the debt. It's when the plan needs more that the lender looks again.

If the plan needs a larger limit on the investment split, or a new lender, you're assessed again. The lender tests the repayments at a rate at least 3 percentage points above the one you'd pay, so a loan at 6% is tested at 9% or more [2].

APRA also limits how much of each bank's new lending can go to people whose total debts are six or more times their income, to 20%, counted separately for home buyers and investors [3]. On $100,000 of income, $600,000 of debt is six times. A larger limit can move a household into that group. That isn't a ban, but it's lending each bank has to ration.

If a higher limit takes the loan above 80% of the home's value, lenders mortgage insurance (LMI), the insurance a lender takes out and you pay for, normally applies [7]. See how much can I borrow.

Debt recycling or borrowing more against your home?

Debt recycling and borrowing more against your home are different moves. Debt recycling aims to keep what you owe the same and change what it's for. Borrowing more, sometimes called equity release, adds new debt on top, which means more risk and a fresh lending assessment (part 17).

Both can use a separate investment split, and the same rule about purpose applies to both [1]. If you're weighing the bigger step, such as a deposit on an investment property, see using equity to buy an investment property.

Can you debt recycle into an investment property?

You can debt recycle into an investment property, but it changes the lending a lot. A property needs a deposit and buying costs in one go, so it's a much larger loan than a round of spare cash, and it's assessed as new borrowing: the test rate, APRA's debt-to-income limit and LMI above 80% all come into play (part 17).

The purpose rule is the same [1]: the money for the property comes from its own split. For a plan that grows past one property, see building a property portfolio.

Which shares or ETFs should you debt recycle into?

Which shares, ETFs or funds to debt recycle into is a question for a licensed financial adviser, not a broker, and this page doesn't answer it.

The loan side asks one thing of whatever you choose: it's bought straight from the investment split, so the trail is clean. The ATO's rule turns on the borrowed money being used to earn income [1]. Whether a particular investment does that for you is for your accountant.

Is debt recycling the same as debt consolidation?

No, debt recycling and debt consolidation are different. Debt consolidation rolls other debts, such as credit cards or a car loan, into your home loan, usually for one lower repayment. Debt recycling keeps the home loan's total the same and turns part of it into money borrowed to invest.

If consolidation is your question, see debt consolidation home loans.

When should you start debt recycling?

From the lending side, the time to start debt recycling is after the structure is in place and before the first dollar is recycled. Set up the splits, check the features (part 13), agree the records with your accountant, and then run the first round.

Some moments make the set-up easier: when a fixed rate ends, when you're refinancing anyway, or when a loan is being restructured after a purchase. Whether now is the time to invest is your adviser's question.

What happens when the home part is paid off?

When the home part is paid off, debt recycling stops: there's no home debt left to recycle, and all of what you owe is the investment split. Before the last round, check what your lender does with a split at zero, because on some systems it closes (part 13).

From there, what to do with spare cash is a fresh question, and it's for your adviser and accountant.

Where a broker's job ends and an adviser's begins

Money Brain's job is the loan: the splits, the features, the lender that can run the structure cleanly, and the application.

Whether debt recycling suits you, what to invest in and how the tax works are questions for a licensed financial adviser and your accountant. We're happy to work alongside them, and the structure is easier to get right when all three are talking before the first round.

This page is general information about how lending works. It isn't tax, financial or personal advice.

What does a broker cost you?

How a broker is paid, and the rule Money Brain holds against it, is set out in full on its own page: what a mortgage broker costs.

Your first move

You've read how the loan has to work. Now there's one question left: can your loan, with your lender, run it cleanly, or does the structure need to change first? That's what Money Brain works out before anything changes.

When you're ready, the closing section below is the simplest way to start.