Tax Tip 522: Borrow Extra or Debt Recycle? Which is better?

Discussion in 'Accounting & Tax' started by Terry_w, 24th Jul, 2023.

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  1. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

    18th Jun, 2015
    Australia wide
    Homer has a $1mil home loan with a loan of $500,000 and $500,000 in the offset account.

    He wants to borrow to buy a $500,000 investment property and has a choice

    a) Borrow an extra $100,000 against the main residence, or

    b) Split the existing main residence debt into $400,000 and $100,000 and then debt recycle by using $100,000 cash to pay down and redraw the $100,000 loan split and to use that as deposit on the IP

    Which is better?

    It depends

    Generally, the interest rate on the debt recycling will be at the owner occupied rate in the above example while borrowing extra will result in the interest rate being at the investment rate.

    This would mean it might result in lower interest rate by debt recycling – but this would be relatively minor. 0.1% difference on $100,000, for example, would be $100 per year. If the rate difference was 0.3% then this would be $300 which is a bit more but still not too much.

    Does Homer have excess cash? If so borrowing an extra $100k at a higher rate might not result in more interest if he has another $100k cash with which to park in the offset account attached to the $100,000 split.

    What about borrowing capacity? It will be harder to borrow an extra $100,000 so if borrowing capacity is very tight then debt recycling might work better.

    Future use of the cash is also important to consider. $500,000 cash is a substantial amount and it could be used to acquire another property once all the existing borrowing capacity has been used up. So borrowing extra now and keeping the cash available for later might be a strategy worth considering. With no more borrowing capacity, Homer could debt recycle the $500,000 loan and borrow to buy one more investment property.

    The cash could be used by lending to a more tax efficient entity too. For example Homer could maximise his tax deductions for the investment properties by borrowing to buy them and then later remove the cash from offset by debt recycling and onlending to a trust to buy positively geared shares where the income could be streamed to Homer’s spouse who is on a low income. This gives him more tax savings and the spouse more income which is taxed at a lower rate.

    There is also the change in circumstances aspect. What if the lending situation changes for Homer. He might lose his job and not be able to borrow more at some point, or he might not be able to borrow as much as he had hoped.

    Therefore, for these reasons it might generally be better for the borrowing extra to occur first and the debt recycling later.
    craigc likes this.