Debt recycling getting popular in Australia

Debt recycling

Debt recycling allows someone who is already paying off a mortgage to borrow up to 80 per cent of the value of their house if they could meet their repayment obligations

Australians are taking novel steps to borrow for a home without spending years saving up for a traditional mortgage deposit as property prices soar.

With house values at record highs across most of the country, getting a home is harder than ever as prices continue to surge in the low-interest environment.

That has created a greater popularity of debt recycling, which allows someone who is already paying off a mortgage to borrow up to 80 per cent of the value of their house or apartment if they demonstrated they could meet their repayment obligations.

Bank recycling enables home-owners to borrow against their equity (the amount they have already paid off their mortgage) to take out another loan to buy an investment property which can be rented out.

Michael Yardney, the director of Metropole Property Strategists, said debt recycling was a good way to make money, provided a borrower’s second loan was used to buy an appreciating asset. Re-borrowing or recycling those funds means you now have “good debt” because, you can use this to buy an appreciating asset that will bring in cash flow every month.

However, debt recycling is risky.

AMP said borrowing against the equity in your home could leave a home owner facing ruin should their second property go down in value or struggle to find a tenant.

Debt recycling is considered a high-risk strategy because you’re using borrowed money to invest and using your own home to secure that debt, it said. If your investment performs poorly or interest rates increase, you could face significant financial stress or even put your family home at risk.

The Reserve Bank of Australia (RBA) has vowed to keep interest rates at a record low of 0.1 per cent until 2024 but that doesn’t mean banks can’t raise their standard variable mortgage rates before then.

If the interest rate on your loan isn’t fixed, a rise in interest rates can lead to your repayments increasing, AMP said. This can put pressure on your cash flow, which can be compounded further if the income from your investments is lower than expected.

Mr Yardney, a proponent of debt recycling, cautioned against a home borrower using the equity in their home to take out a new loan for a car, a depreciating asset.

Unlike an investment property that is rented out, a borrower can’t claim negative gearing tax breaks.

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, Mr Yardney said.

Unlocking the equity in a home someone has partially paid off also spares someone from having to spend years saving up for a 20 per cent mortgage deposit, potentially making them miss out on capital growth as property prices surge.

Property price records were set in 53 of Australia’s 88 sub markets in February.

Now, three of the big four banks are offering fixed mortgage rates of less than 2 per cent.

Disclaimer: The opinions expressed by our writers are their own and do not represent the views of Getting Money Wise. The information provided on Getting Money Wise is intended for informational purposes only. Getting Money Wise is not liable for any financial losses incurred. Conduct your own research by contacting financial experts before making any investment decisions.

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