- Financial Planning Strategies and Economic Insights
Using your equity to build an investment Portfolio
Build wealth via debt recycling
While it’s important to reduce inefficient home loan debt as quickly as possible, it’s also important to build wealth for the long-term to meet you lifestyle goals (such as retirement). Many people tend to wait until their home loan is paid off before thinking about investing. Unfortunately, this means they tend to invest later in life, and don’t give investments time to grow. One solution is to employ a debt transformation strategy using a financial windfall. Another way to reduce inefficient debt as quickly as possible, and build long term wealth tax-effectively, is to use a strategy known as debt recycling.
How does the Strategy Work?
This strategy has three steps:
1 – Use the equity in your home to borrow for investment
2 – Use the investment income and tax savings arising from the geared investment, as well as your surplus cashflow, to reduce your outstanding home loan balance.
3 – At the end of each year, borrow an amount equivalent to what you paid off your home loan during the year and use this to purchase additional investments
This Process is continued until your home loan is repaid. After that, your surplus income (including investment income and tax savings) can be used to acquire additional investments or pay down your investment loan.
Case Study
Bob & Barbara have a home worth $450,000 and an outstanding home loan of $220,000. They are keen to pay off as quickly as possible and would like to start creating long–term wealth. Having spoken to you (the financial adviser), they have decided to employ a debt strategy.
They use existing equity in the family home to borrow for investment purposes. they’re comfortable having a total debt level equivalent to 67% of current ($450,000) value of their home (ie $300,000). Given their outstanding home loan is currently $220,000, they will initially borrow $80,000 via an interest only investment loan, and invest it in a Australian Share fund.
Throughout the first year, they use all of their surplus cashflow, around $10,000 (less the interest on the investment loan), and the investment income and tax savings, to pay down the home loan by $24,047 to $195,953. They then replace the amount paid down by borrowing an equivalent amount as an investment loan ($24,047) to purchase additional units in their share fund.
If they continue this process, their home loan will be paid off after 8.8 years. After recycling at the end of that year, the investment loan would be fully drawn to $330,000 and the value of the share fund would be $410,352. With the home loan paid off, they can direct all surplus cash flow, investment income and tax savings into the share fund.
Benefits
* Create an investment portfolio sooner by replacing inefficient debt with efficient debt
* Use investment income and tax benefits from your geared portfolio to reduce your inefficient debt faster
* Accelerate the creation of wealth and attain your lifestyle goals sooner
If you are interested on pursing this strategy please contact Jason Abrahams or Robert Wolski on (02) 9436 0099.