Good Debt vs Bad Debt – The Power of Debt Recycling

Mario thinks I’m playing games. Last week I suggested his home is not an asset. This week I have asked if he knows the difference between good and bad debt.

Being a very proud Italian, he says, “Ina Italy, we paya cash for everyting. That’sa a gooda debt. Anyting else, that’sa a bada debt”.

Thankfully Maria laughs before I do!

Welcome to lesson two of the End of Financial Year Master Class series – ‘Good Debt vs Bad Debt and the Power of Debt Recycling’.

Mario and Maria have approximately $150,000 in cash. They would like to buy an investment property while interest rates are low, however they also have a mortgage on their house for about $250,000.

Last week I suggested they could do both. To achieve this, I begin by explaining the difference between good debt and bad debt.

Good debt is tax deductible debt. That is, debt which is used to buy income producing assets. E.g. an investment property.

Bad debt is non-deductible debt. E.g. the debt on your home.

Next I explain a strategy called ‘debt recycling’.

Debt recycling is the process of replacing non-deductible debt with deductible debt. It can be very tax effective.

Immediately Mario’s eye’s light up!

“I likea tisa one. Cana youa do for us?” He beams.

To that end, I recommend the following strategy.

1.    Put the $150,000 cash onto your mortgage thereby reducing your non-deductible debt from $250,000 to $100,000.
2.    Re-draw that $150,000 in the form of an investment loan to use as a deposit to purchase your investment property.

This strategy will deliver three key benefits:
•    Reduce the mortgage on your home
•    Enable you to purchase an investment property
•    Recycle your debt. I.e even though you will still have total debts of $250,000, $150,000 (60%) is now tax deductible debt.

Mario is so happy he wants to know if this is legal! Maria gives him a gentle backhander.

I explain to Mario and Maria there are many forms of debt recycling which can be used to reduce debt and build investment portfolios. It can be especially powerful for business owners.

If Mario thought I was playing games at the top of the conversation, next weeks lesson will send him into a spin. I will be explaining why I wouldn’t buy an investment property to save tax.

Mario has stopped listening. He doesn’t want to spoil the party.

Have a great week and if it feels like a bad one, recycle it.

When the moon hits your eye like a big pizza pie
That’s amore
When the world seems to shine like you’ve had too much wine
That’s amore…

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