With property prices increasing significantly over the last couple of years many homeowners have found themselves with substantial equity. Some homeowners want to put the equity to use for investment with many opting to try and buy an investment property, but there is another way that some put that equity to work. The other popular strategy is debt recycling. Both could help you grow your wealth, but they work in very different ways. In this blog, we’ll explore the pros and cons of each strategy to help you decide which one might be right for you.
What Does It Mean to Release Equity?
Releasing equity means accessing the value you’ve built up in your home. For example, if your home is worth $800,000 (average Perth house value is $809,870) and you owe $400,000 on your mortgage, you have $400,000 in equity. You can access some of this equity by refinancing your home loan or having an additional loan secured against your property. It’s worth noting that lenders will generally allow you to increase to 80% of the value of the property without incurring lenders mortgage insurance, so in this scenario up to $240,000 could be released.
Once you’ve released equity, you can use the funds for various purposes, such as:
- Buying an investment property.
- Investing in shares or other assets (debt recycling).
- Renovating your home.
- Funding other personal goals.
Two of the most common wealth-building strategies using released equity are buying an investment property and debt recycling. Let’s break down each option.
Option 1: Buying an Investment Property
Using your equity to purchase an investment property is a popular strategy for building long-term wealth. Here’s how it works:
- Access Your Equity:
- Use your home as security to release the equity and get an investment loan to purchase the property, or take out an additional loan to use as a deposit.
- Purchase an Investment Property:
- Use the released equity as a deposit for a rental property or use your existing home as security (cross-security).
- Generate Rental Income:
- The rental income can help towards the mortgage repayments and other expenses.
- Benefit from Capital Growth:
- Over time, the property may increase in value, building your wealth.
Pros of Buying an Investment Property
- Tangible Asset: Property is a physical asset that you can see and touch.
- Rental Income: Provides a steady stream of passive income.
- Capital Growth: Historically, property values tend to increase over time.
- Tax Benefits: You may be able to claim tax deductions on expenses like interest, repairs, and depreciation.
Cons of Buying an Investment Property
- High Costs: Purchasing property involves significant upfront costs (e.g., stamp duty, legal fees) and ongoing expenses (e.g., maintenance, property management).
- Illiquidity: Property is not a liquid asset, meaning it can take time to sell if you need cash.
- Market Risk: Property values can go down as well as up, and rental income may not always cover expenses.
- Management Effort: Managing a property (or paying a property manager) can be time-consuming and stressful.
Option 2: Debt Recycling
Debt recycling is a strategy that converts non-deductible debt (like your home loan) into tax-deductible debt by using the equity to invest in income-generating assets, such as shares or ETFs. Here’s how it works:
- Access Your Equity:
- Additional home loan or set up a line of credit to release equity.
- Invest in Income-Generating Assets:
- Use the released equity to invest in shares, ETFs, or other investments.
- Convert Debt to Tax-Deductible:
- The interest on the borrowed funds becomes tax-deductible because the money was used for investment purposes.
- Use Investment Income to Pay Down Debt:
- Any income from your investments (e.g., dividends) can be used to pay down your home loan faster.
Pros of Debt Recycling
- Tax Efficiency: The interest on your loan is tax-deductible, reducing your taxable income.
- Wealth Creation: You can grow your investment portfolio while paying off your home loan.
- Flexibility: You can choose the types of investments that suit your risk tolerance and goals.
- Faster Debt Reduction: Investment income can help you pay down your home loan faster.
Cons of Debt Recycling
- Market Risk: Investments like shares can be volatile, and you could lose money.
- Complexity: Requires careful planning and management to ensure the strategy works effectively.
- Interest Rate Risk: Rising interest rates can increase the cost of your loans.
- Debt Levels: You’re taking on additional debt, which increases your financial obligations.
Key Differences Between the Two Strategies
| Aspect | Investment Property | Debt Recycling |
| Asset Type | Physical property | Shares, ETFs, or other investments |
| Income Source | Rental income | Dividends, capital gains |
| Liquidity | Illiquid (takes time to sell) | Liquid (easier to sell investments) |
| Tax Deductions | Yes (interest, repairs, depreciation) | Yes (interest on investment loan) |
| Management Effort | High (property management required) | Low (passive investments) |
| Risk | Market risk, vacancy risk, maintenance costs | Market risk, interest rate risk |
Which Strategy is Right for You?
The choice between buying an investment property and debt recycling depends on your financial goals, risk tolerance, and personal preferences.
Choose an Investment Property If:
- You prefer tangible assets and are comfortable with property management.
- You want steady rental income and long-term capital growth.
- You’re willing to take on the responsibilities and costs of owning property.
Choose Debt Recycling If:
- You want to diversify your investments beyond property.
- You prefer a more flexible and liquid investment strategy.
- You’re comfortable with market volatility and want to maximise tax efficiency.
Can You Do Both?
Yes, it’s possible to combine both strategies. For example:
- Use some of your equity to buy an investment property.
- Use the remaining equity to invest in shares or ETFs through debt recycling.
This approach allows you to diversify your portfolio and benefit from both property and share market growth.
Final Thoughts
Releasing equity from your home can be a powerful way to grow your wealth, but it’s important to choose the right strategy for your circumstances. Whether you decide to buy an investment property, debt recycle, or do a combination of both, make sure you:
- Seek professional advice from a financial planner and your accountant.
- Speak with a mortgage broker to confirm your borrowing capacity.
- Carefully assess the risks and rewards of each strategy.
- Regularly review your investments and adjust your plan as needed.
By making informed decisions, you can put your equity to work and take a big step toward achieving your financial goals. If you’d like to know what your equity and borrowing capacity is contact us or you can book an appointment here.
Disclaimer: This blog is for informational purposes only and does not constitute financial advice. Please consult a qualified financial advisor or tax specialist before making any decisions.