Debt recycling is a strategy that lets you convert your non-deductible home loan into tax-deductible investment debt — without borrowing any extra money.
The name sounds a bit suspect, but it's a completely legitimate and ATO-approved approach that's been around for decades. Here's how it works.
Understanding Good Debt vs Bad Debt
Your home loan is what's called "bad debt" — not because owning a home is bad, but because the interest you pay isn't tax-deductible.
However, if you borrow money to invest in assets that generate income (like shares or investment property), that interest becomes "good debt" because it's fully tax-deductible.
Debt recycling is simply the process of gradually converting one into the other, without increasing your total debt.
How the Recycling Loop Works
Use spare cash to pay down your home loan
Redraw that same amount and invest it in income-producing assets
That redrawn portion is now tax-deductible (because it was borrowed to invest)
Use the investment dividends to pay down more of your home loan
Redraw again, invest again, repeat
Each cycle converts more of your non-deductible debt into deductible debt.
A Practical Example: Tom's Situation
Tom owns a property worth $600,000 with a $450,000 mortgage. He has $80,000 in his offset account.
Most people would just invest that $80,000 directly. That's fine — but it misses a tax opportunity.
Step 1: Split the loan
| Loan | Amount | Purpose |
|---|---|---|
| Loan A | $370,000 | Home loan (non-deductible) |
| Loan B | $80,000 | Investment loan (tax-deductible) |
Step 2: Pay down and redraw
Tom uses his $80,000 cash to pay Loan B down to zero, then immediately redraws that $80,000 and invests it in a diversified Australian ETF yielding approximately 4% in dividends.
Because those funds were explicitly borrowed to invest, the interest on Loan B is now fully tax-deductible.
The Numbers
| Item | Amount |
|---|---|
| Interest on $80K at 6% | $4,800/year |
| Tax saving (37% bracket) | $1,776/year |
| Dividends (4% yield) | $3,200/year |
| Franking credits | ~$1,370/year |
| Total annual benefit | ~$6,346 |
Franking credits are tax credits attached to dividends — the company has already paid tax on those profits, and you can use the credit to reduce your own tax.
Tom deposits the dividends into his offset against Loan A, reducing interest on his non-deductible debt. Once he accumulates enough, he repeats the process — paying down Loan A and redrawing from Loan B to invest again.
Long-Term Projections
| Timeframe | Total Invested | Portfolio Value* | Tax Saved |
|---|---|---|---|
| 10 years | $180,000 | ~$300,000 | ~$30,000 |
| 20 years | $280,000 | $600,000–$800,000 | ~$80,000 |
*Assuming 8% average annual growth
The total loan amount stays the same — but progressively more of it becomes tax-deductible.
Is This Strategy Right for You?
Debt recycling works best if you:
- Own your home with a mortgage (you need debt to recycle)
- Have spare cash in savings/offset, or accessible equity
- Have stable income and comfortable cash flow
- Are comfortable with a longer-term loan structure (Loan B is typically interest-only)
Risks to Understand
| Risk | What It Means |
|---|---|
| Investment risk | Share markets fluctuate — you could lose money if you need to sell during a downturn |
| Interest rate risk | Rising rates increase your interest costs |
| Cash flow risk | Dividends aren't guaranteed and don't arrive monthly like a salary |
Getting the Structure Right
The most common mistake is poor loan structuring. The ATO requires you to keep deductible and non-deductible debt completely separate.
Key requirements:
- Split your loan from day one
- Never mix investment and personal funds
- Maintain a clear paper trail from loan redraw → investment account
- No co-mingling of funds
Two Methods
Cash method
If you have savings, pay down part of your loan, split it, redraw, and invest.
Equity method
If you've built up equity over time, access up to 80% of your property value as a separate investment loan. This has an added benefit — if you later convert your home to an investment property, the loan structure is already clean.
The Bottom Line
Debt recycling can be a powerful wealth-building strategy if you have a mortgage, spare cash or equity, and a long-term mindset. But it requires discipline, proper structuring, and professional advice.
Before implementing this strategy, speak with a financial adviser and accountant to confirm it suits your circumstances. A mortgage broker can then help with the loan structuring.
Disclaimer
This article provides general information only and is not personal financial advice. Debt recycling may not be suitable for everyone. Speak with a licensed financial adviser and qualified accountant before implementing this strategy.
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