{"id":1929,"date":"2022-02-21T06:11:48","date_gmt":"2022-02-21T06:11:48","guid":{"rendered":"https:\/\/royabhishek.in\/urbanbuyer\/what-is-it-and-how-to-earn-money-from-your-debt\/"},"modified":"2022-02-21T06:11:48","modified_gmt":"2022-02-21T06:11:48","slug":"what-is-it-and-how-to-earn-money-from-your-debt","status":"publish","type":"post","link":"https:\/\/royabhishek.in\/urbanbuyer\/what-is-it-and-how-to-earn-money-from-your-debt\/","title":{"rendered":"What is it and how to earn money from your debt?"},"content":{"rendered":"

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Please use the menu below to navigate to any article section:<\/p>\n<\/div>\n

You were probably taught by your parents to get a good education, a good job, buy a home, work really hard, and pay off your debt.<\/strong><\/p>\n

\"MoneyBut, in my mind, that\u2019s not a productive use of the equity in your home or your investment properties.<\/a><\/p>\n

Instead, you should recycle the equity in your home<\/a> and convert it into productive debt to buy income-producing assets.<\/p>\n

But before we start delving into all things debt recycling, let\u2019s start out by clarifying the difference between good and bad debt, and how having debt can actually benefit you, and set you on the path to financial freedom.<\/p>\n

The three types of debt<\/span><\/h2>\n
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  1. Bad debt<\/strong>:
    This is a debt against assets that depreciate in value.
    Bad debt<\/a> generally refers to things like credit cards or other consumer debt that does little to improve your financial outcome.<\/li>\n
  2. Necessary debt<\/strong>:
    This is the non-tax-deductible debt against your home, but it\u2019s something essential that can\u2019t really be avoided.<\/li>\n
  3. Good<\/strong> debt<\/strong>:
    This is a tax-deductible debt against income-producing and appreciating assets. Think loans against residential investment properties business loans.<\/li>\n<\/ol>\n

    This is the type of debt that can help build wealth and bring you cash flow over time.<\/p>\n

    Not all debt is bad debt<\/span><\/h2>\n

    Somewhere along the line, you were probably taught that debt is a problem.<\/p>\n

    But, I don\u2019t agree with that. <\/p>\n

    Having debt is not a problem.<\/p>\n

    Not being able to repay<\/em> your debt (or interest on your debt) is the problem and that\u2019s why it\u2019s so important to understand the difference between good and bad debt.<\/p>\n

    Having said that, in today\u2019s economic environment I believe good debt is an asset.<\/p>\n

    Now I know that may sound counterintuitive but let me explain\u2026<\/p>\n

    In the old days, when you owned an investment property your mortgage repayments would have likely been more than the rental income you received meaning most \u201cinvestment grade\u201d properties were negatively geared \u2013 and this resulted in a cash flow shortfall.<\/p>\n

    The tenant would have contributed to some of your mortgages by paying you rent, the taxman would have assisted with depreciation allowances and negative gearing benefits, but each month you would have had to contribute to your mortgage repayments.<\/p>\n

    However, today, taking on good debt and borrowing at historically low-interest rates and using leverage to grow your assets while at the same time receiving rent that is likely to cover your interest payments is a sound investment strategy.<\/p>\n

    Your cheap debt is an asset because you are using it to create more equity (as the value of your investment property improves) plus cash flow.<\/p>\n

    And you can accelerate this by using debt recycling.<\/p>\n

    What exactly is debt recycling?<\/span><\/h2>\n

    Simply put, debt recycling is a strategy that turns your current home equity into a tax-deductible investment loan.<\/p>\n

    If like many Australians you bought your home a while ago and have been slowly re-paying your mortgage debt, and all the while your property has increased in value, you would now have significant equity in your home.<\/p>\n

    \"WoodenSo my suggestion is to borrow against this unused equity and buy an investment property.<\/p>\n

    Previously that debt against your home was \u201cnecessary debt\u201d but re-borrowing or recycling those funds means you now have \u201cgood debt\u201d because, as I just explained, you can use this to buy an appreciating asset that will bring in cash flow every month.<\/p>\n

    But here\u2019s the catch \u2013 to recycle your equity into good debt, the debt can\u2019t just be used for anything.<\/p>\n

    If you borrow against the equity in your home to buy a car or as other debt used for personal purposes, the interest payments are not tax-deductible.<\/p>\n

    Just to make things clear, it\u2019s not the security against with you borrow the money (your home) which determines if the interest payments are tax-deductible.<\/p>\n

    It\u2019s the purpose of the loan such as borrowing to invest, which makes interest tax-deductible.<\/p>\n

    How does debt recycling work?<\/span><\/h2>\n

    Debt recycling may be a little confusing, so let\u2019s explain it with a seven-step guide.<\/p>\n

    1.<\/strong> Over time you will have paid down a portion of your home mortgage with a principal and interest loan and during that time your home would have increased in value.<\/p>\n

    The difference between the current value of your home and the outstanding amount on your mortgage is your equity.<\/p>\n

    2.<\/strong> The bank will often lend you up to 80% of the value of your home as long as you can show serviceability. \"Debt\"<\/p>\n

    3.<\/strong> You would take out a new investment loan using your available home equity as security and the purpose of this loan would be to use the funds as a deposit on an investment property.<\/p>\n

    Imagine your home is worth $600,000 and your available equity is $300,000 because you\u2019d paid your mortgage down to $300,000.<\/p>\n

    You could recycle $150,000 of this equity as a loan \u2013 in other words, take out a new investment loan for $150,000 which would be then used as a deposit for an investment property, using the equity in your home as security.<\/p>\n

    This would leave you with a loan to value ratio of 75% ($450,000 loan on a $600,000 property) well within banks lending parameters.<\/p>\n

    4.<\/strong> You could use this $150,000 to invest in assets that produce both income and capital growth such as a managed fund, shares or as a deposit against an investment property.<\/p>\n

    5.<\/strong> You could even use the income generated from your investments, plus any tax advantages of a geared investment, to pay off the non-deductible debt in your home loan.<\/p>\n

    6.<\/strong> Over time you will build your wealth as your investment property or share portfolio should increase in value over time and the cash flow you receive in the form of rental or dividends should also increase. \"Home<\/strong><\/p>\n

    7.<\/strong> At the same time you will slowly be paying down the mortgage on your home, so that when you reach your retirement years and start enjoying the longest holiday you will have in your life, you will own your own home with no debt and have an investment portfolio of properties or shares (preferably both) with a manageable level of debt.<\/p>\n

    In order for a debt recycling strategy to work you need the following:<\/p>\n