What is your debt recycling strategy ?

I dont have one yet. So I am looking to learn how others here do it.
What is your debt recycling strategy ? Or what are the strategies you have known of ?

Cheers,

 

Broadly there are 2 types
a) positive cash flow
b) capital gains

Each of these can be broken down into several strategies
for example
- share dividends
- share sales
- positive cash flow property
- periodically selling property
- negative geared property (reverse debt recycling) and then sell with a large gain
- using the main residence CGT exemption
- incorporating trusts
- spousal sales
- spousal loans
- related party sales
- related party loans
- small business concessions
etc etc

 

In general - debt recycling of property purchase costs through the PPOR loan into separate splits.

Now - recycling into shares - easy way to draw cash flow by borrowing at sub 4% interest rates and then buying ~6% net yielding assets.

If you have strong enough cash flow and can redirect any dividends into the loan this can be a potent strategy - ie a 500k debt recycle would pay itself off just over 10 years. Add in dividend growth, rising wages and you can build a healthy portfolio to balance your property assets.

 

That's possible, but only for a particular subset of people!
I can only get those figures to work with a $500k share portfolio, 100% franked, with 0% MTR, IO loan, loan interest of 3.8%, dividends of 6% (to go with MTR=0%; mix and match for your own, like MTR=32.5%, gross yield=8.2%).
So it works best for someone not working or retired (MTR=0%), with $500k in shares. I can't see how it could work in super in pension mode as it's possible to take the money out of the undeductible debt, but it can't be added to in pension mode (can it?).

 

I worked on the attached excel spreadsheet for myself, but it maybe useful for others. It's based on debt recycling via share dividends which is only the first do point in Terry's list. Comments, errors found and ideas for improvement welcome .

 

You're double-counting dividend income - assuming that it is re-invested in stock and then fed back into the portfolio via line 21

 

Corey when you say borrowed funds at sub 4%, are you referring to the standard home loan rates?

I have home loan rates under 4% (investment and new ppor) but if I use those funds I can't claim the deductions as the original loan purpose was for property.
I can do seperate splits as you say into line of credits which then means the purpose can now buy shares and the loan interest can be claimed as investment, but they are no where near sub 4%, they are near 5% and above.

Asked my accountant if I should use the 4% offset cash from home loan funds which the interest is not deductible, or the higher 5% line of credits which is deductable, he said to use the higher rate which is deductable. Hope to clarify this when I meet up with him at our appointment.

 

Its not the purpose of the original loan that determines deductibility of interest but the use to which the borrowed money is put.

I suggest you borrow at the owner occupied rate to invest where you have equity in the owner occupied home.

 

If you have a loan that's sub 4%, split that out and repay from your offset, and redraw to buy shares.

 

Bingo - thank you very much! Updated version is attached.

 

As Jess and Terry have noted - purpose not security is the important thing to remember.

This is where a savvy broker who understands debt recycling strategies can help with appropriate lending structures - ensuring you're with a lender which will allow you to actively adjust your loan splits and draw from loan accounts - saves you having to re-apply for lending and if setup right can then allow you to be getting cost effective rates.

Not everyone can qualify for these types of facilities - so get advice from a broker who knows what they're doing to see if you might be able to do similar.

 

very good advice from @Corey Batt @Jess Peletier and @Terry_w. With the current tightening lending environment, investors with large portfolios ( or even a reasonable size of portfolio) are finding it very difficult to grow their portfolio. Maybe it is a good time to look at strategies to reduce non productive debt, such as PPOR loan, by using debt recycle strategy. a good FP is gold, @Alex Straker, are you able to elaborate more for us pls?

 

Been saying so for the past couple of years Its been bleeding obvious for quite some time.

My clients are all well set. They have each added several cash cows to their portfolio's during the past 3-4 years and are now well on the way to paying down their PPOR mortgages much faster than would have been possible if they'd continued making minimum monthly repayments. So even if the P&I cliff comes their way in the next couple of years, they are well set to deal with it as they have created very large buffers against any future shocks.

Anyone can do this. Its not too late to recalibrate. All it takes is one or two cash cows to keep a portfolio safe from the P&I cliff. Problem is, it requires that you think laterally. You see, you need to purchase the extra income required for said reduction of non productive debt, before your borrowing capacity becomes non existent No point having an epiphany after your borrowing capacity runs out . By then, its too late to recalibrate.

 

Sure Eric, happy to

As a result of the massive property boom in Australia the biggest drag on most modern Aussie's ability to get ahead faster is their high levels of non-deductible debt. Debt recycling is the 'rolls royce' strategic approach to eliminating non-deductible debt quickly. The great Aussie dream of home ownership now means taking on a massive mortgage in many cases and this leads to poor cashflow and limited financial progress for many years if not addressed quickly.

Why listen to me on this topic? As some here are aware (thanks Eric!) I regularly conduct industry training for the likes of AMP FP's on this strategy and have been specialising in it for over 12 years with around 80% of client base doing this strategy and I am the original developer of the industry leading DR software for financial planners.

A typical DR plan outcome for example would be paying off a 25 year home loan in under 5 years. DR is complex, requires a thorough understanding and management of risks plus a myriad of structural details to get the most out of it. For these an many other reasons I would strongly encourage anyone considering DR to get advice. Few important points for consideration (general info only, no advice):

• To run a solid DR strategy the focus should be non-deductible debt reduction and maximising cash flow efficiency to achieve this.
• Over using leverage is a HUGE problem and margin lending can destroy this strategy if not used wisely (a-la 'Storm Financial' who were double gearing every client in to index funds, not using appropriate buffers, ran a flawed software model, lied about client's incomes to get more borrowed funds etc). The modern industry considers best practice is not to use margin lending and I have written a white paper for AMP on optimising structures and cash flow algorithms for DR. Using unleveraged home equity for DR is highly effective, however there are other alternative (and much safer) ways to apply additional leverage without using margin lending.
• MUST adhere to a disciplined household budget and thereby enforce their savings habit to consistently drive down non-deductible debt.
• Investment needs to be tailored to the over all strategy and individual preferences. There are multiple reasons why you should NOT use direct property for the investment portfolio, it does not work efficiently for this strategy. A quality blue chip share portfolio is far more effective.
• A lot of the efficiency of this strategy is gained through fully franked blue chips driving a high tax efficient yield, naturally this helps pay down the non-deductible debt faster over time.
• Capitalising interest is never a good idea for this strategy as it adds to the risk.
• Periodic limit adjustments need to be made to the non-deductible and deductible splits and one of the most important considerations is to set up the right kind of facility to make this convenient and relatively painless. Many standard loan facilities are completely unworkable for DR purposes due to lack of flexibility to make regular split adjustments without having to re-write the whole loan, incur more fees etc.

I have seen a number of clients over the years who claim they already have set up their own debt recycling plan and then after them explaining to me what they have done it turns out that what they have is nothing even remotely close to debt recycling and there are all sorts of problems, risks and inefficiencies. Again in my view it is crucial to get advice with such a potent and potentially life changing strategy. I only wish someone had taught me this strategy in detail earlier in life when I first bought a home, it works like magic for debt elimination.

 

Well...yeah you actually can do this with resi property... just perhaps not the "vanilla" type you and other planners may be more familiar with. It requires something such as NRAS or dual income to work, but it works. Both these types of resi property investment will work just the way a "blue chip" share portfolio works... they will generate " fully franked dividends" . ie an after tax surplus. That surplus can then be reinvested for debt reduction. In other words, dividend reinvested .

BUT here's where the differences are ... resi borrowing is superior to margin lending as DSR's are higher so more income can be purchased , LVR's are higher so less cash or equity is outlaid so again, more income can be purchased . And it can all be done while avoiding "at call" margin lending, and without the volatility of the share market to worry about .

Nothing at all wrong with what you are proposing.. I also advocate debt reduction and you'll see #decadetodeleverage on everything I post. I'm just pointing out that using the right categories of resi property means it can be done... and I think it's safer than with shares and margin lending. I dont expect you'll agree - but nevertheless.... the numbers are the numbers

 

Thanks for your input I am highly familiar with the NRAS scheme and could not possibly advocate this approach to debt recycling. I agree with some of your points (debt reduction focus particularly) and I guess the debate over whether you can do debt recycling properly using direct property will depend on how you define debt recycling. Under my definition (and I have been specialising as a financial planner in this strategy for over 13 years and provide training on it to major institutional advisers) I remain of the view you cannot do DR effectively using direct property.

1. It is fundamentally the wrong direction to go in if the client is already overweight in property assets (as is usually the case). Increasing holdings in a single asset class is adding to risk where as using another high performing asset is reducing risk.

2. You stated that the NRAS property will do the same job as 'fully franked dividends' and give an 'after tax surplus'. Sorry but this is false. An 'after tax surplus' is in no way the same benefit as fully franked dividends and will not deliver an equivalent income tax outcome. Direct property does not and never has carried the same tax benefit as franking credits on blue chips. The only way to get that tax benefit on property exposure us through a market listed property trust that pays fully franked dividends. The importance of the tax benefit of franking credits for this strategy is crucial and adds thousands of $ income per annum to the income being paid in to the home loan and is an important for maximising acceleration of the downward movement in non-deductible debt.

3. Debt recycling relies on the fact it is a highly 'dynamic' strategy meaning the investment accumulation is done regularly (for most of my clients this is monthly). I cannot think of a single client who could do this using direct property, you can't buy a property every month (unless you are already in a position where you would not need to) but you can accumulate shares in small amounts regularly.

 

Have been debt recycling for a while, new split for big investments or group of smaller investments. So many splits now that if I go to a CBA branch, I have to show them the "more" button to go to the next page of accounts to find my offset

Tax-deducted investment loan interest rate: 2.83%
Portfolio return after fees and taxes: 8.07%
Net return: 5.24%

 

We will have to agree to disagree about how familiar you are with the NRAS... the number of times someone has started a dialogue with me by telling me how well they know NRAS, or how familiar they are with NRAS, only to leave the dialogue or conversation having been re-educated... . lets just say I've lost count. It's especially worrying that you are arguing that a property generating thousands of dollars of tax free surplus income ( NET after tax income) isnt providing the same opportunity to reduce non deductible debt that a share portfolio generating fully franked dividends ( also NET after tax income) produces. Sorry ,but what I wrote is not false. Its bang on. I know this because I do it. My clients do it... and you only need see their (or my) mortgage balances to know it works...

Lets compare apples with apple to demonstrate the point; For this exercise let's compare the use of cash. I can deploy as little as 12% + stamp duty towards, let's say a 300K NRAS purchase - and generate 8-10K CF+ after tax. That's a deployment of @ 48K of cash for a return of 8-10K .... or @16.67 - 20.83% on the 48K. And that's the after tax result. Where can I invest 48K of cash in shares and get 16.67 - 20.83% or better, after tax?

Cant. Thats the answer. (or if I can, it will carry extreme capital risk) And why? Because property allows for leveraged investing that share investing doesnt. Resi mortgages are secured and can be had for as little as 12% + stamp duty contribution . Margin lending is unsecured - and at call, and generally capped at much lower LVR's. But lets not get into a debate about the merits of one versus the other . Thats not the point. The point is.... using the correct combination of NRAS property and LVR, I can get a 16.67-20.83% return on as little as 48K. And that's a fact.

To your point that debt recycling needs to be dynamic. Respectfully - I disagree. The volume or frequency of purchases is a nonsense argument. Whether I had purchased 4K of shares each month or 12K of shares per quarter, or 24K of shares twice per year, or invested 48K in 1 x NRAS purchase per annum, I deployed a total of 48K for a return of 8-10K NET. Yes? No? Now, dynamic is a nice word and conjures up all kind of emotional responses about magical, mythical possibilities - which we know planners love as a sales tool ... but under scrutiny its a nonsense argument in the context of this discussion at least. Total investment and total return on that investment are far more useful measures. 48K of cash invested is 48K invested, whether it's done in 1 or 12 or 24 or 48 increments.

That all being said.. I have no issue with what you proposed in your earlier post. Aggressive debt reduction is exactly what I am all about. Its a concept I support completely. You are absolutely correct that its a strategy everyone should embrace. I was only pointing out that while you recommend using "dynamic" high frequency share purchases to achieve it , the same sorts of outcomes can also be achieved using less frequent, less "dynamic" resi property purchases - provided those resi purchases produce the sorts of NET after tax (fully franked) dividends that shares can - and NRAS does that when employed correctly.

 

What do you guys use as your geared vehicle? Is it pure Aussie equity/LICs/ETFs/derivative income strategies? What about sustainability of earnings and hence dividend payments?

Do you use unlisted property syndicates, REITs (including non mainstream agri REIT like RFF), multi-asset income funds, etc.

With the underlying geared vehicle, what is the attitude for capital at risk? For example, a blue chip portfolio of ASX listed stocks may produce a high divvy, but the capital value could tank (e.g. Telstra in recent times). Arguably ASX is quite richly valued. Do you mitigate by simply not selling and hoping to ride it out, long term investing?