Debt Recycling

[ffc1883_1996]

"Debt Recycling". This is a term that's sometimes briefly mentioned in a number of threads but I'd like to explore it in more detail because I'm beginning to feel that it's benefits are underestimated by property investors. I've been investing for years but only began thinking about this concept after discovering Somersoft and reading some great contributions by investors such as Rixter and MichaelWhyte and, in particular, a brilliant post by Corsa.

For those of us with a PPOR mortgage (or any personal debt) the opportunity to reduce that loan using IP rent, while capitalising all associated investment costs in a separate tax deductible line-of-credit, may have little effect in the short term but be very beneficial in the bigger picture.

Using this type of structure, even if my property were to have a pretty ordinary year (say, for example, 5% yield plus 3% growth minus 8% cost of finance), I'd still be in a better position at the end because a portion of our personal debt would be recycled into a tax-deductible loan. Our investment debt would accumulate quickly but our PPOR debt would be fast approaching zero. The benefits would be realised with the submission of each tax return for years to come.

I wish I'd known about this years ago!

 

[Stella]

We are only relatively new to IP's but this is the structure we are working with thanks to our MB. I had never heard of 'recycling debt' until he introduced us to it. Takes a little bit to get used to not paying anything off the IP but it's very nice seeing the rent pay off a bit more of our PPOR each month

The only personal debt we have is our PPOR & the theory is whenever we build up a reasonable available amount in our PPOR LOC (say $20k) we move $10k into the other a/c which pays IP IO repayments for the next few months & drop our LOC limit by $10k - works for us!

Cheers
Stella

 

[ffc1883_1996]

To take this point a little further, I wonder if I'd be better off to withdraw all of the excess funds in our investment line of credit (7.39%) and deposit them in a BankWest savings account (7%). This will increase our tax deductible debt repayments and also increase our taxable income (which I'd use to recycle PPOR debt).

The loss that I'd incur in the short term (difference between 7.39% and 7%) would bring about a gain in future years due to the overall reduction in non-deductible PPOR debt.

Not sure but I think this would increase our serviceability for future loans as well because I'm told that lenders assume that your LOCs are fully drawn when reviewing your application and don't consider any undrawn funds to be a secure means of servicing a new loan.

 

[Simon]

Some of us run a similar exercise but use an income based share fund that historically has returned funds in excess of the interest charged on the LOC.

This works quite well though a bit slow.

A more aggressive investor might choose to borrow 80% of all equity in property. Double this via a margin lending account and place it all in the income oriented share fund to kill the PPOR and other nondeductible debt asap.

Not without it's risk but has worked well in the last few years.

 

[Cherry Pro]

Simon

What kind of 'income oriented share fund' are you talking about here ?
Something akin to Navra ?

Thanks.

 

[Simon]

Simon

What kind of 'income oriented share fund' are you talking about here ?
Something akin to Navra ?

Thanks.

Navra is one. Some research should find you some more of them.

I would rather not suggest any. My points above are not advice either. Just some ideas I am familiar with to get people thinking of possibilities.

Ciao,

 

[Kenster]

... withdraw all of the excess funds in our investment line of credit (7.39%) and deposit them in a BankWest savings account (7%)

This is certainly one way to do it, albeit it would incur loss in real money (to be offset partly by tax credit).

It is possible to generate better return than 7% through the options others have mentioned, with or without extra gearing (through margin loans).

Other options are to put money into investments that provide you with income, such as businesses, IPs, shares or derivatives (options, warrants, dividend run-up).

 

[The Y-man]

The loss that I'd incur in the short term (difference between 7.39% and 7%) would bring about a gain in future years due to the overall reduction in non-deductible PPOR debt....

No.....this won't work....because the amount you recover from tax will be less than the amount you lose.

Cheers,

The Y-man

 

[Ausprop]

the main problem, without reading the following thread again and it has been a while since I read it, would be the ATOs view of what you are doing. could it be considered aggressive tax planning?

http://www.somersoft.com/forums/showthread.php?t=26532

 

[FrankGrimes]

A more aggressive investor might choose to borrow 80% of all equity in property. Double this via a margin lending account and place it all in the income oriented share fund to kill the PPOR and other nondeductible debt asap.

Not without it's risk but has worked well in the last few years.

Has anyone got a spreadsheet for doing this? I would be interested to see it in action over time.

 

[FrankGrimes]

Has anyone got a spreadsheet for doing this? I would be interested to see it in action over time.

First go at it attached..

Assumes PPOR purchase price 750k
Share divs 5% (banks, lics etc)

Seems to work ok.. ? My spreadsheet needs work though.. Will have a go on w/e

 

[Dean1337]

I must be really misunderstanding something here. How is debt recycling any different to drawing on equity? It seems to be the same to me.

I'm guessing the idea is that you pay off your PPOR asap and as its equity increases you draw down on that equity and use it to get a loan on another investment whether it be shares or property. For example, property's value increases by 30k and you've payed off 30k, then you can use that 60k of equity to purchase another IP. Which in effect has transferred 30k of non-deductable debt you use to have into deductible debt. So where has my understanding of this gone wrong?

It might be obvious to some here that I haven't purchased my first IP yet.

 

[ffc1883_1996]

How is debt recycling any different to drawing on equity?

It's the same thing. However, the trick is to ensure you structure your affairs so that you not only borrow to purchase the IP, but you also borrow to pay for ALL of the associated ongoing costs. Meanwhile, your using ALL of the income to fund your own lifestyle and non deductible debt.

Follow this link:
http://www.somersoft.com/forums/showthread.php?t=26532
It's fantastic!

 

[ffc1883_1996]

Has anyone got a spreadsheet for doing this? I would be interested to see it in action over time.

I look forward to seeing your updated spreadsheet. For your assumptions, could I suggest that you use the Navra fund's stated aim of 2% growth and 10% income. This would appear to be a popular fund for property investors.

 

[FrankGrimes]

I look forward to seeing your updated spreadsheet. For your assumptions, could I suggest that you use the Navra fund's stated aim of 2% growth and 10% income. This would appear to be a popular fund for property investors.

I'm personally not that comfortable with the Navra fund. I guess there is nothing stopping you from sell down growth shares to pay down PPOR debt.

 

[ffc1883_1996]

I'm personally not that comfortable with the Navra fund.

I'm not too comfortable with the Navra fund or with share investing in general. However, I do understand the view that a balance of high yield investments can be a useful tool for property investors with a negatively geared property portfolio to recycle debt, cover any IP shortfall and increase your serviceability for future loans.

I don't think 5% share divs would really assist with this any more than just buying another property. Your thoughts?

 

[Dean1337]

It's the same thing. However, the trick is to ensure you structure your affairs so that you not only borrow to purchase the IP, but you also borrow to pay for ALL of the associated ongoing costs. Meanwhile, your using ALL of the income to fund your own lifestyle and non deductible debt.

Follow this link:
http://www.somersoft.com/forums/showthread.php?t=26532
It's fantastic!

Thanks ffc, it certainly was a fantstic thread.

 

[The Y-man]

I must be really misunderstanding something here. How is debt recycling any different to drawing on equity? It seems to be the same to me.

No need to wait for growth of your PPOR to recycle debt.

eg.
PPOR loan $200k
You pay off $5k of your ppor loan with your pay
You immediately draw down the $5k and buy a dividend paying share.
Now your loan is $200k again BUT
$195k is non-taxdeductible
$5k is now tax deductible

Following month
You pay off another $5k from your ppor loan with your pay
You immediately draw down the $5k and buy a dividend paying share (so now you have $10k of shares).
Now your loan is $200k again BUT
$190k is non-taxdeductible
$10k is now tax deductible

etc

Cheers,

The Y-man

 

[FrankGrimes]

I don't think 5% share divs would really assist with this any more than just buying another property. Your thoughts?

I guess all its doing is helping convert non deductible to deductible.. But lets say one LIC/share does

5% div
5% growth
10% total

navra does
8% distribution
2% growth
10% total

If you sold some of the "growth" and pay tax you would be no worse than an "income" fund.. ie you would be taxed at your marginal tax rate in both cases

 

[Dean1337]

No need to wait for growth of your PPOR to recycle debt.

eg.
PPOR loan $200k
You pay off $5k of your ppor loan with your pay
You immediately draw down the $5k and buy a dividend paying share.
Now your loan is $200k again BUT
$195k is non-taxdeductible
$5k is now tax deductible

Following month
You pay off another $5k from your ppor loan with your pay
You immediately draw down the $5k and buy a dividend paying share (so now you have $10k of shares).
Now your loan is $200k again BUT
$190k is non-taxdeductible
$10k is now tax deductible

etc

Cheers,

The Y-man

Thanks Y-Man,

It makes a lot sense. However, I do have a slightly more technical question. If I was to draw down on this 5k then effectively I've borrowed 5k to purchase shares. If I only use this 5k to purchase shares then my current LVR is 100%. To my understanding banks usually will not go along with a 100% LVR share portfolio. So, extending your example above, would you use 5k of you own savings and then purchase 10k worth of shares so that the LVR is at 50% instead? I'm very interest in doing something similar to this concept but the details are escaping me.