#25 Debt recycling: how to use your home to build passive income (and smash your mortgage)

Terry: and welcome to the passive income project

back to the passive income project. It’s Terry here and I’m here with Ryan. Good to see you, mate. You too, mate, today, we’re going to be talking through what we believe to be one of the best wealth building strategies for homeowners that most people have never heard of. So talk us through this topic a little bit more.

Ryan: Yeah. This is probably the most underutilized strategy in Australia as well. Like something where there’s so many people that have the capacity to do this, but just don’t know it exists. I guess last week we talked about. The different types of debts. We talked about investor debt, being debt that helps you buy assets and put income in your pocket.

And then the consumer debt, which is more to buy things that don’t grow. They don’t have an income. And then we talked about having the mortgage that somewhere in the middle, where it’s not necessarily putting income in your pocket because you don’t earn rental income or anything like that from your home, but it does grow in value.

So your home does grow in value. So, what we’re going to talk about is how do you actually build up the second dimension of that asset, which is the income part. So that does grow in value, but there is also helping you earn an income too. So

Terry: converting it from that sort of muddy middle, not quite consumer debt, but not quite invested at taking it from that middle place, taking it across to really useful debt.

That’s actually that invested

Ryan: debt. Yeah. It’s actually going to grow your wealth. That’s right. So, and remember, we’re talking here about the debt. We’re not talking about the house. It’s not about how we build out the house so that it helps us own income. It’s about the debt that’s associated with that house.

A little bit different, but we’ll get into it. Yeah. And there’s

Terry: three clear benefits for this. Isn’t there a few really big payoffs that if this works really well and you can implement and execute it, the precision, what did I get?

Ryan: So the first one is you pay off the home loan faster, which is a golfer.

Most people that have a mortgage it’s get rid of that bloody thing. And then the second money is pay a lot less taxes, probably tens of thousands of Bella’s worth of tax over the decades. And then the last one is. Stop building your passive income from your portfolio sooner. I think we sort of fall into this idea that we build up.

We save our money towards buying a home. Then we get a big debt against that. And then we just focus on repaying the debt until it’s pretty much gone. And then we start building up our investments thinking about retirement. Whereas this is thinking about starting that investing journey much, much sooner so that you can get the benefits of compounding and building that portfolio over time.

Yeah. And I think there’s

Terry: a lot of people in this situation, right. That are starting to educate themselves and go, Oh, damn, I’ve got this home loan. Now I’m learning about this investing stuff, but I have to wait. It’s almost like going no, no, it’s not either. Or there is a place where you can do both. And so this strategy is all about helping you do both.

So that, like you say, you can start to harness the power of time with your money because yeah. Like we always talk about time is your number one ally when it comes to investing. So how do we co-op that. And get that ally on our side

Ryan: sooner. Absolutely. Thinking about this point in time now. Yeah. Like the state of play of how things are evolving right now, home loans have low rates, but they’re taking longer than ever to pay off.

We’ve got a generation that wants more freedom and they want it sooner, but that’s directly at war with that mortgage taking longer to pay off and it’s getting easier than ever to manage your own wealth. Yeah. Technology is making it really easy to manage and see how your money’s working.

Terry: It’s kind of a window in the past.

This has probably been, just kind of kept behind the cloak of only professionals can do this, but there are more and more people managing this and figuring out how to do this for themselves. So in the past you would probably have to go to an advisor and they’d pay you, charge you a lot of money to set up this for you and sort of then monitor it.

But now the way those things have changed. And I guess the way our drivers have changed as well has meant that a lot of people have started to explore this and use this strategy themselves.

Ryan: Yeah. And I think it’s also just the development of the knowledge industry as well. We talked a couple of episodes ago about how it’s, there’s more opportunities than ever to invest in yourself and learn.

And I think this is also becoming more popular because people are getting better at educating themselves around things like this, or just investing in general, rather than saying I’m going to go to a broker or to a financial advisor to do this. They’re understanding it for themselves. And I think this is the next layer.

It’s one understanding the investing, but then it’s also understanding the strategies as well, that tie in

Terry: everything’s kind of getting democratizing this way. Yeah. Information is not an advantage anymore. Okay. So we’re going to explain exactly what the strategy is. And let me just spoil the joke for you.

It’s called debt recycling. We’re going to talk you through exactly what it is. We’re going to talk you through the key ingredients that must be present for this to work. We’re going to give you the six steps for baking this cake. And then a clear example of what this could look like for the typical Aussie capital and the bottom line in terms of the payoff we said before, it can help you pay it off sooner and reduce your tax.

We’re going to show you exactly how much based on some pretty conservative assumptions. And then we’re going to talk you through what needs to be true in order for this to work. And also for this to work for you because this strategy is not for everyone. You have to be at a particular place and says that your conflict with debt number one.

Your ability to know how money is moving through your life is probably the second one. And you certainly would. That is probably a couple of really clear prerequisites.

Ryan: Yeah. It’s a bit of a gangster move. It is a gangster move and you’ve got to have some decent balls to do it, but the balls come from one dipping your toe in the water and like becoming familiar with investing and becoming more comfortable with debt, but also in understanding it as well, like most things, you know, Building that understanding and that experience.

And then it becomes a lot easier to make a big gangster movie.

Terry: Yeah. So if you just paid off your credit cards, probably not the right time now it’s probably not, but, and probably it’s a good time to have this disclaimer as well. Like this is not financial advice as none of our stuff is this is financial education.

So you’re responsible for the decisions that you make and if you need assurance or you’d actually prefer to be told, then it is a good idea to go and consult an advisor. So, if you’ve been learning about personal finance, you’ve been listening to this podcast you’ve been going, yeah. This investing stuff.

I liked the idea of this building, my passive income sort of buying back my time, but you’d been thinking, Oh man. But most of my money has to be channeled to my mortgage. Right now, this episode can give you another path another way. And so we’re going to lay it all out for you. Hopefully this can be a lot of value for some people.

Ryan: Yeah. So debt recycling is a strategy where. You use the equity in your home to buy shares, to build up a passive income that helped you repay your home loan. And over time you converting your mortgage into investor debt. So the difference between that mortgage and invested at is you can’t claim the interest on your mortgage as a tax deduction.

Whereas with the investor debt, you can, so one is helping your own home, which is just helping you with growth and having your own space. Whereas the other debt is helping your boss shares that will pay you an income stream and grow in value. And

you,

Terry: you said the word tax deduction there, and let’s just quickly talk about what you mean by tax deduction.

Ryan: When you think about, let’s say you’re in a hundred thousand dollars, right? And you’ve got a debt that costs you $10,000 a year in interest you have to pay for that debt unless that’s $10,000 and owning a hundred K if that $10,000 is. From your home loan, that means it’s consumer debt. Then you pay tax on a hundred thousand dollars.

So taxable income is a hundred thousand. It doesn’t have any impact. Yep. Whereas if that $10,000 of interest is for your investor debt, then it would reduce that a hundred thousand taxable income to 90,000. So you pay. Tax on $90,000 worth of income. And this depends on your tax bracket, blindsides that 90 to 100,000, that could be three, $4,000

Terry: saved.

Yep. So you saving your money on tax and it’s exposing you to growth and income that you wouldn’t otherwise be exposed to at the same time. Yeah, that’s right. Correct. Yep. And so that’s how it helps you pay down things a lot faster. Okay. So it sounds to me like, it’s almost like you’re converting fat to muscle.

It’s not that useful to selling it is. Yep. That’s probably why we call it a gangster move. Isn’t it? Because you’ve sort of gone from, you’re not exposed to growth and income and also all your wealth tied up in the home. And we talked about that as a risk. You’re now spreading that risk and exposing yourself to more sources of growth and income.

Yeah. So that’s how it’s kind of accelerating things for you as well. Yeah. Yeah. That’s right. I can hear what’s going off in people’s heads right now. So they’re saying, wait, wait, wait. So you’re telling me to take money out of my safe home, which is traditionally perceived to be a safe asset. You’re telling me to take it out of there and you’re telling me and put it into the risky stock market.

What would you say to somebody who’s like that? Right. It

Ryan: really tested me that a key part of that is. You’re reducing concentration risk. And you remember back to episode eight, I believe we talked about it. So if all your wealth is tied up in just your home, it’s very concentrated. Whereas if you’re taking some of that equity out and you’re using that to buy.

A diversified portfolio. Let’s say it’s an index fund, for example. And that owns 200 or 300 companies, then you’re actually spreading your risks. So you’re diversifying, like they’re saying you don’t have all your eggs in one basket. It’s it’s spreading out yeah. Your eggs basically. You’re

Terry: [00:09:39] taking those eggs and spreading.

Ryan: [00:09:41] Yeah. Yeah, yeah. And the second part of it is also opportunity costs. As we talked about, we’re getting into some modeling in the host that would direct you to afterwards. You could be leaving hundreds of thousands of dollars on the floor.

Terry: [00:09:52] Absolutely. And it’s also, like we said, at the start too, like. The sooner you get your money invested, the harder time works for you.

So, if you’re waiting until you’ve got your home loan paid off, then there could be a decade or decades worth of opportunity that you’ve missed out on there in terms of growth of that money. Yeah. So we’re saying you don’t have to do that. If you think about this strategy, it’s not for everyone, but it’s an opportunity for those of you that are comfortable enough with debt.

And you can think about how you might want to use that. And I think it’s about making the shift from just thinking, pay down debt to get debt free, to grow my wealth really. Isn’t it. It’s a mindset shift.

Ryan: [00:10:27] Yeah, absolutely. It’s about, it’s also for the person that just wants to optimize everything, like to make sure that you’re doing everything you can to stack the odds in your favor of building wealth.

Like it’s for that person. Because as you said, it’s not necessarily about paying down debt because once you understand how that works and like become comfortable with it, you don’t actually want to be debt free. No, like you want to have invested debt so that you can have more assets that are growing and doing more for you.

So it’s definitely not about debt repayment. It’s about converting that consumer debt into investor debt, and then just managing your debt levels in a comfortable way.

Terry: [00:11:02] Yeah. From painful to useful. Okay. So let’s talk about the ingredients. What do we need to make this strategy work?

Ryan: [00:11:08] So the first thing you need is a home.

Obviously, otherwise this would make sense. The second part is a mortgage that you’re looking to convert. Third one is productive equity, which we’ll dive into in a minute. You need a surplus in your cashflow to know that you’ve got some

Terry: [00:11:21] space. So the ability to save consistently and. And some certainty with that, right?

Ryan: [00:11:25] Yup. That’s right. And then lastly, confidence in your ability to earn income in the future. Cool.

Terry: [00:11:31] So that’s what makes it be true, but what about for the person themselves? Like how do they, are there some, I guess character traits that make this more suitable for some rather than others?

Ryan: [00:11:40] Yeah, definitely. I think the first one is definitely discipline.

Like the ability to be consistent and delay gratification as well. Like not to get caught on the shiny things.

Terry: [00:11:50] Yeah. This is not a get rich quick scheme. We’re not saying through this and next year you’re home freight. That’s not what

Ryan: [00:11:55] we’re saying is that’s not a magic bullet. Like everything we talk about in this podcast, it’s, time-tested principle based.

It’s not about waking up in six months time and living on the moon. It’s something that takes time and it takes discipline and it takes consistency as well. And as I said before, it’s for that person that wants to optimize everything. So you need to be disciplined with that. And then also. You need to be diligent, like be able to monitor things, to optimize the strategies as things changed as well, just pay attention to things and how they’re moving and, you know, things like the interest rates, for example, just be across when things like that are changing.

Yeah. Because

Terry: [00:12:30] all those things impact the strategy and you need to kind of move and the job. Yeah.

That’s

Ryan: [00:12:34] it. And you get plenty of warning for those things. Like it’s not that interest rates aren’t going to go from 2% to 10% and give you a side.

Terry: [00:12:41] No, if that happened, most of the developed world would go under water.

Yeah, absolutely. And then look, it’s probably worth saying here as well. Like if you like the idea of the strategy, but you don’t see yourself as the person to do it and you can get help and you probably should, if you think that it’s worthwhile exploring

Ryan: [00:12:56] yeah. You pay someone to do it for you. It’s still going to be worthwhile.

No doubt. You give up some fruits by doing that. And the compound effect of fees over time do make a difference, but you can ask for help and it’ll still be worthwhile. Do you think that it’s

Terry: [00:13:09] possible to get help just to get it set up and then monitor it and sort of manage it yourself to kind of get the, do the most of the legwork for you?

Ryan: [00:13:16] Yeah, I think so. And that’s probably worthwhile if you’re chatting to an advisor saying, Hey, I’d like to make this a project to get this set up and get educated on the ins and outs of it and then go about managing it yourself. And it might be something where you’re checking every three or five years and come back and make sure that it’s all still right.

And everything’s going well. That’s probably a

Terry: [00:13:35] good litmus test to it. They should be able to do a better job of educating you than we are right now, or else they don’t

Ryan: [00:13:40] understand that. Yeah, that’s a good test. And it’s also like, they’ll understand your position and understand what you’re working towards, your goals, your financial sort of position and your income and all of those things would consider all of those things and then put together a plan for you.

And they need to be able to educate you throughout that process. So you should come away with it. Very confident to be able to walk away in a manger for the next three to five years, at least because it

Terry: [00:14:03] is, it’s a five. Plus year strategy at least is at

Ryan: [00:14:07] least yeah. 10, 15, 20 years

Terry: [00:14:09] plus. Okay. So let’s talk through the recipe in terms of the steps.

And look, it’s probably worth saying at this point, we’ve already mentioned it, but Ron’s written a pretty in-depth blog posts. That’s gone a little bit viral in some of the five groups here in Australia. So if you want a really good in-depth guide, you wrote that because there wasn’t a good God was there.

There was just a lot of people kind of talking on the periphery about it.

Ryan: [00:14:29] Yeah, I think there was a few people just like sharing their opinions on it. And there wasn’t anyone that really delve into it, like trying to understand it from a step by step basis so that people can actually learn it and implement it.

I wrote that maybe four or five months ago, we didn’t actually share it on our website, but we put it on a page and people just found it organically. I think it’s been our most viewed page the last six months. Hasn’t it. So, yeah, like you can see that hungry to learn more about it and for it to be laid out in a sequential order so that people can follow the steps.

Terry: [00:14:58] We’re just going to talk on a high level through these steps and sort of more conversationally do it. But if you want to follow along or even want more, the depth, it’s really good idea to look at that ultimate guide. And obviously as always, the links can be in the show notes for you. So he needed to scroll down and click the link.

You’ll have what we’re talking about and you can actually follow along the conversation or read it after

Ryan: [00:15:16] the fact. Yeah. Yeah. And I think this is an important one to raid because of crowded storybooks, basically, and heaps of images, because it can be a little bit abstract because there’s a few moving pieces with it.

So it’s good to sort of chunk it down into each step, have a visual cue for each of those. It’s really embedded in your thinking and then bring it all together at the end. So it’s definitely worthwhile jumping in there and having a look at that. All right, cool. What’s step one. So step one is building equity.

So creating that productive space that I mentioned before. And so when I say productive space, the way I think about a home is like this. So thinking about the equity in your home, there’s four key. Equity elements. The first one is the roof. So picture a house, but picturing the roof and the roof is 20% of the equity.

So maybe you’ve bought a house, you’ve put up the 20% deposit and basically that 20% there, you never want to touch. It’s protecting you from the elements. Yeah. The storms of mother nature. And

Terry: [00:16:13] when you say the elements, you mean volatility and the housing market to sell and at the wrong time and yeah.

Ryan: [00:16:17] Yep. So property value can go down by 20% and you’re not in negative equity, for example. So you never really want to touch that 20%. It protects you from the elements and then there’s the ceiling. So that’s an extra 10% and that’s more about just giving you some comfort. There’s a bit of insulation in there and it’s keeping the house warm.

All right. And so 10% you can touch, but you shouldn’t, this is your margin of safety, right? It’s a margin of safety. So the roof 20%, and then you’ve got the ceiling at 10%. So 30% of the equity in your home. So let’s say you’ve got a million dollar home just for an easy round number. 30%, which would be 300,000 of that equity.

Don’t touch it, just leave it there, enjoy the comfort, knowing that you’re going to be okay if your markets move reasons dramatically.

Terry: [00:17:02] Yeah. So the market would have to drop more than 30% for you to be any trouble.

Yep.

Ryan: [00:17:05] But then anything underneath that 30%, you’ve got some room to move and that’s what I would call productive space.

And that is the difference between beneath that 70%. And what have you mortgages? So let’s say for that example, the million dollar home, you’ve got a mortgage of 500,000 and productive equity was up to 70%. There’s 200,000. That is in that productive space range that you could potentially use for that next move.

Whether or not that’s investing in, it could be going towards, uh, a second property, for example, is quite a common thing. Or it could be going towards something like this debt recycling. Yeah. Yeah. So for equity elements, the roof, which is 20%. The ceiling, which is the next 10%. And then you’ve got the productive space and the mortgage that make up that remaining 70%.

Terry: [00:17:50] Basically the rule of thumb is if your loan to value ratio is less than 70%, you’ve got productive space and you can consider this strategy if not, talk to us about money mapping be,

Ryan: [00:18:01] and that’s right. So if your loan to value ratio, which just to really break that down for you, loan to value ratio is how much debt you’ve got divided by the value of your home.

So let’s say that $500,000 mortgage. And the million dollar home that would be 500,000 divided by a million, which would be 50% loan to value ratio. So that’s a really quick math one, but as you said, if you do that math and that LVR is over 70 or over 80 or over 90, forget more importantly, you’re not there yet.

You need to really focus on that debt repayment and managing your cash flow is the most critical part. Getting that down, like being really intentional with how you’re spending without waste. So you can get there sooner. You can start that investing. Okay. So if that’s you

Terry: [00:18:43] right now and you’re thinking ARCA, I don’t need to listen to the rest of this podcast.

Here’s what I want you to do fast forward to the last two minutes and listen to the last two minutes where I’ll talk you through a video training, we’ve got it’s around the four factors you need to maximize your cashflow. Follow that, watch that because those things in place will help you. Yeah.

Supercharger saving that way. All right, so that’s step one. We’ve gotta be building our Eckery login to create some productive space. Step two. What do

Ryan: [00:19:09] we do now? Yes. So then we go about setting up an investment loan or a line of credit sometimes used here, but basically an investment loan that is secured against your home that is using some of that productive equity.

Okay. So let’s say that $500,000 mortgage against a million dollar home. It might be that you borrow another a hundred thousand dollars on top. So the total debt is 600,000. 500,000 is still your mortgage. And a hundred thousand dollars is invested debt, which takes me to step three. I’ll jump straight to the next one.

That is then using that a hundred thousand dollars to buy a portfolio, build your portfolio. Well,

Terry: [00:19:47] we’re talking about getting time to work for you sooner because you’re not having, you’re sort of saying, okay, cool. I’ve got some productive space, so let’s get that time working for us right now. This is critical,

Ryan: [00:19:57] right?

Yeah. And it might not be that you’re in a place right now where you’ve got that a hundred thousand or 200,000 and productive space. You might be at 70% on the dot and the next 5,000 that you paid down, you could borrow 5,000. Personally, I like to get probably on the 65% and then stop from there. And you might borrow up to 70% and really this comes down to understanding your own appetite for risk as well.

Like how comfortable you are, how well you sleep at night, or you might actually prefer having a ceiling of 20% or 30% for extra comfort. Yeah. So you might not touch the first 40% of your equity.

Terry: [00:20:31] So the other thing to consider here is that you want your investment choices to be income focused. Yeah.

Cause I’ve got to the income needs to exceed your interest if possible, which means that that’s going to sort of mean that Australian stocks are a bit more attractive. Yeah,

Ryan: [00:20:45] absolutely. So I guess if you look at the contrast between. International shares or U S shares versus Australian shares. Let’s say there’s a 10% return on the U S style versus the Australian style.

The U S you’re probably looking at more like 8% growth in 2% income, or even a little bit less income. Whereas Australian it’s more like. 6% growth and 4% income. Yeah. So it’s a little bit different. There’s a higher incentive for Australian companies to pay out higher income because of our tax system and the removal of double taxation, which is a whole nother story.

But what that’s sprayed in and what that’s created is franking credits as well, which helps the investor less tax

Terry: [00:21:24] we’ll have a link to the show notes. We’ll have a link in the show notes on that one as well. We’ll get down a bit of a wormhole,

Ryan: [00:21:30] but we won’t go too far in the weeds on that one, but

Terry: [00:21:32] basically just.

More passive income

Ryan: [00:21:34] because you’re borrowing and you’re paying interest on the investment loan to buy the shares you want to have at positive cashflow. So let’s say it was 3% for the cost of the loan, the interest on that loan. Then you want to be owning three and a half percent income or 4% income.

And then you’ve got a little bit of Frankie on top, which creates a bigger margin because that’s the margin between the cost of the loan and the income that you’re receiving that helps you pay extra off your mortgage. It’s positive income and helps you pay more off that mortgage, which helps you pay it off sooner.

Probably

Terry: [00:22:07] why right now with interest rates so low, it’s a pretty opportune time. Isn’t it like the record lows in terms of the home loan and then from investment terms in Australia, you can assume that it’s going to be anywhere between three to 5% in terms of that return. So. Right now that differential is pretty good.

Ryan: [00:22:22] Yeah, absolutely. And that sort of ignores the growth part because he probably also going to have, you know, over time between three and 5% growth on the portfolio. But for this strategy, you want to focus on the income and the cash flow part of it. And then the growth just be the cherry on top. Yep.

Terry: [00:22:39] So that’s step three.

What’s that

Ryan: [00:22:40] for? Yeah. So step four is. Like I just said, so using the income, that extra margin, basically the difference between that 3% income and what you were saving income and the return with the tax to pay extra off your mortgage. So paying that off sooner, and

Terry: [00:22:56] once you’ve done that step five, what are we doing

Ryan: [00:22:58] now?

Yeah. So the next step is then just using that margin. So the difference between the cost of the loan, the interest and what the income was from the portfolio. Plus the tax return. So at the end of the year, you’ll get some tax return money. So using what you kept as well as the extra dividends that you didn’t use to pay the interest and putting that back into the mortgage.

And then it’s just rinse and repeat. Yeah.

Terry: [00:23:25] What you just said there in terms of using that difference, the tax return part. Yep. That’s where people can get tripped up with this, right? Yep. What would they do if they

Ryan: [00:23:32] did it wrong? Our main shopping center, right?

Terry: [00:23:35] Well, we go to these tax fag. No, you got to put it into this to make this work.

Yeah.

Ryan: [00:23:40] You want to get that $5,000 tax turn or whatever it ends up being and use that. Instantly to wipe off the mortgage. And then as you wipe off that mortgage, you might even do the same thing. Again, draw up another $5,000 in investment loan, put it into the market, keep that cycle going. So once this is set

Terry: [00:23:57] up, it’s just a repetitive process where you just like, if this, then that, if this, then that, if this, then that it’s just to getting it set up and sort of understanding it.

That’s the real thing.

Ryan: [00:24:06] Yeah. Like to really now that if they send that, so step one, pay off mortgage step two. Increased investment line. Step three, with that loan that you’ve just increased Bosch as a patio, a good income step four, pay off the interest with that income. The difference, put that towards the mortgage.

Step five. When you receive your tax return, put that money against the mortgage and do the whole thing again

Terry: [00:24:30] and repeat and repeat and repeat for years. Yep. Until

Ryan: [00:24:34] you get the result. Yeah. And then it’s just add time.

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Okay. So let’s do a work example because we did say this would help you accelerate your wealth. It would help you pay off your home loan sooner. So let’s talk about some actual numbers with regards to that. So in your posts, in this ultimate guide, you did it pretty slick example of Shas and Douggie, Chason

Ryan: [00:26:09] jogging.

Just your typical Aussies.

Terry: [00:26:12] This storybook that you put together basically gets shows how these guys over the course of 20 years, Paid off their mortgage, four years faster, saved 18 K on tax in the process and ended up $596,000 better off when it comes to their net worth. And at the end. Yeah.

Ryan: [00:26:31] And this is the big one.

Terry: [00:26:33] They also had 41 grand in passive income every year in perpetuity. From that point forward. So that’s pretty cool. So let’s talk about how this strategy let’s talk through that example and how you got to those numbers. Yeah.

Ryan: [00:26:46] So I call this a storybook strategy. So this is where I try to understand things myself.

And like, when I first learned about this, I go deep into financial modeling. I go deep on the projections. And so I want to understand how those things fit together. I want to understand all the variables and if you change one thing, what does that mean for the 20 years time? And when it comes to this cause, uh, for these long-term strategies, You want to know what subtle changes make over time.

And so for this one, we’ve got Doug and Shazzie our favorite two Aussies basically set the stage. She says she owns 70 K per annum, Douggie and 65 K per annum. And together their living expenses are $80,000 per year. So just to think about that income and what they’re spending, and then their situation is their house is worth 700 K.

And then mortgage balance is currently at 420,000. So when we think about those equity elements, the house at $700,000. So 20% of that, which is 140,000. Never want to touch that’s the roof. I don’t want to touch that 140,000. It’s just going to sit there, protect them from the elements. And then they’ve got the ceiling, which is 10%.

So 10% of 700,000 is 70,000. So an extra 70,000 there. So the 140 plus the 70 $210,000 in equity, they’re never going to touch. Okay. So once you type that 30% off you’ve then got $490,000. In productive space. Okay. But right now the mortgage is 420,000, which means they’ve got $70,000 in productive space.

So what’s available to them is $70,000. So in this strategy, what they’ve decided to do is not use that whole 70,000. They’re going to be a little bit. Risk averse. They’re just going to take their time with it. And they’re just going to use $35,000 of that and invest it into an index fund, which is focused on Australian businesses because of the income component.

And so to break it down, what they’re doing is they’re borrowing $35,000 against their home. They then going to use that to invest in a low-cost high-income index fund made up of Australian businesses, and they’re going to direct all of their surplus cashflow for the repayment of their mortgage. As that mortgages were paid, they’re going to further borrow the same amount each time by the investment loan and invest it.

Okay. And once the mortgage is repaid, they’re then going to direct all surplus cashflow, into investing, building up that portfolio.

Terry: [00:29:14] Now this part, this is where this strategy kind of really takes off isn’t it? Because you pay it off sooner and then all the money that you’ve got from that perspective then gets channeled into the investments.

Yeah, I think that’s what people miss with debt recycling because in the beginning it doesn’t look that great, but as you go over time and you see that it starts getting packed and then it’s paid off and then it goes, bang.

Ryan: [00:29:32] Yeah, that’s right. So you mentioned before how, in this example, they pay the mortgage off four years sooner.

That’s four years where they’re basically doubling how much they can contribute to their portfolio. That’s not split between paying off debt and replacing it’s focused just on building up that portfolio. That’s right. And so. What this storybook strategy does is walks you through these different increments and time.

I said after one year after five years, after 10 years after 20 years, what’s happened basically. And there’s a few assumptions or dive into it with that. And so thinking about how our income and our expenses increase with inflation there’s things like what the income and what the growth is. And the franking is for the portfolio, as well as.

Well, the interest rate for the loan is so really mapping out all of those things. Yeah. How they can change over time. Okay. So

Terry: [00:30:21] there’s a few assumptions in there, but let’s just kind of go what’s the bottom line of each year. So I talked about before, how it doesn’t look that great in the beginning, but that story changes a lot over time.

So let’s just go through where you got to with the numbers off the  five and so on and so forth.

Ryan: [00:30:36] Yeah. So after each increment of time, what I’ve done is looked at the highlights. So you can see all of the workings, you can see how it all comes together and where these come from. But basically what you need to know is after you one, they grew their investment by 1200 bucks.

So nothing major, but it’s moving. They increase their tax return by $252. Third one is they increase their free cash flow. So the money that they’ve got available to them by $1,100, which meant that they could pay an extra $1,100 off their mortgage than they otherwise previously could.

Terry: [00:31:08] So you go, Oh yeah, that’s okay.

$1,100. Is that

Ryan: [00:31:10] a whole lot, but knowing that they haven’t worked harder for it, that I’m putting more hours at work to do that.

Terry: [00:31:15] Okay. So that’s your one

Ryan: [00:31:17] at year five. So then after year five, That investment growth is now growing by 4,300 in the last year. They’ve increased their tax return for this last one by $750.

They’ve increased set free cashflow by 4,300. Which means that they’re paying that same amount, that 4,300 off their mortgage, $4,000

Terry: [00:31:38] starting to look a little bit more significant.

Ryan: [00:31:40] Yeah. So in the last year, they’ve now grown the investment by 10,700, they’ve increased the tax return by $1,300. They’ve increased their free cashflow by 11 and a half thousand dollars, which meant that they pay an extra 11 and a half off their

Terry: [00:31:55] mortgage.

Yep. Now he’s starting to get to move in. The trains moving,

Ryan: [00:32:00] that’s picking up same

Terry: [00:32:01] significant. Yeah. Yep. Okay. So we’ve been talking about, I guess, the highlights in terms of cash flows for each of those years, let’s talk about the change in the net position. Now, after 10 years of this strategy,

Ryan: [00:32:11] what does it look like gonna start to pay attention to?

Or how much has it grown by as well as well as how much debt have you now got and what does that mean in the overall scheme of things? So. If you weren’t doing any strategy and you were just focused on paying down the home loan, there was no debt recycling involved. The home would be worth 940,000. So it’s been growing by 3% from the assumptions.

The home loan would be $225,000. So your net position would be 714,000. So nine 40 minus the two 25. Um, it’s at 115 basically. And then with the debt recycling, the home value would still be 940,000 because nothing’s changed there. Your investment portfolio would be 335,000. Your home loan would be 171,000, which is less than the previous version, which was two 25.

The no strategy. This would be 172,000 and then your investment loan would be $283,000. Okay. So in the first scenario you don’t have any investment loan scenario, two you do with the debt recycling, but the overall position. So with no strategy, it was 714,000 with the debt recycling. It would be 821,000.

So it’s $106,000 Kreider. So

Terry: [00:33:27] after 10 years we’re a hundred grand ahead and we’ve got pretty solid source of passive income. So this is starting to look pretty good. Now let’s take it even further. Let’s take it right out to 20 and have that difference

Ryan: [00:33:38] there. So from a cashflow perspective, after 20 years and going back to what we ran through before.

So the investment in that last 12 months would have grown by around 37 K. Would have paid a little bit more in tax now because your income so much higher, but over the timeframe you’ve paid less tax. They’ve increased that free cashflow by 41,000 and this last year, meaning cause the debts now whopped off, it was wiped off after 16 years, meaning they could now invest in extra 42 K a year.

Terry: [00:34:10] That’s pretty good. It’s pretty dramatic. So you’re able to now without doing any extra work, just go. All right. So from this point forward an extra 41,000 every year is going to be gone into growing a money machine. You’re going to end up pretty good, all pretty well, or just go spend

Ryan: [00:34:23] it, all of it, but enjoy your money.

If you’re at that point in time, I’d probably hit the snow for three months of the year.

Terry: [00:34:32] Let’s not sneeze at this. That’s a quite a big change in terms of what’s possible for you and your life. We talk about buying back time, having $41,000 of passive income at this point where a lot of other people are still paying off their debt, their home loan.

That’s a pretty big sort of juxtaposition there. Isn’t it?

Ryan: [00:34:49] Yeah. Yeah. And look like comparing those two and really sort of, I guess, summarizing the difference between doing it versus not doing it. And that’s a big sort of comparison because often people would do something else. So it is like something versus nothing.

But you look at this modeling and the differences, you know, paying off the mortgage for years sooner, increasing net worth by 594 K. Paying $18,000 less in tax while earning an extra 42 K here and free income free cashflow. Yeah, it’s pretty solid for 20 years. What’s really hard is that first five years sucks because it feels like nothing’s happening.

Even the, for up to 10, you’re starting to feel it, but then you go to 20 and it’s a difference

Terry: [00:35:33] story. That’s the theme with a lot of this stuff we talk about, isn’t it like, you gotta be willing to look like nothing’s happening or feel like more support in this testy patients. Yeah. And you get rewarded for that on the backend.

Massively in this case to the tune of 500 and something. Yeah. Which, when you talk about sort of those later years of your life security,

Ryan: [00:35:54] absolutely. And like you probably hearing a lot of numbers here, like things are just being thrown at you. Like what does that all mean? Really encourage you to jump in there, like dive into the numbers and understand it.

It’s all in that post. You can download all the workings, everything that’s behind it, but at least flip through that storybook, it’s a series of slides that you can watch and see how that unfolds. And just see how it all moves, see how things change, how it all links up, because at least the understanding will help you see it as an option, whether or not it’s what you do and what it’s not, it’s going to help you say how things

Terry: [00:36:24] work.

Yeah. Yeah. And there are some really important variables to consider here. Right. And I think it’s probably worth mentioning what those variables on now.

Ryan: [00:36:31] Absolutely. So interest rates. They can increase. Yeah. If the interest rates increase, then there’s a smaller margin between what the income from your investments are and how much you’re putting towards the repayment towards paying the interest.

And on that one,

Terry: [00:36:45] if interest rates increase beyond your income from investments, That makes his strategy not effective at all. Right?

Ryan: [00:36:51] Not as effective, still going to have the growth on top, but you may have to supplement the deficit. You’re

Terry: [00:36:56] going to be filling out from your pocket to sort of make up the

Ryan: [00:36:59] shortfall.

Yep. That’s right on the assumption there that it’s a hundred thousand that you’ve got an invested in it’s a hundred thousand dollars loan. You’re going to be building a margin between those two. So after some time it might be a $200,000 portfolio and there’s only a hundred thousand dollars. In debt.

Yes. So you’ve got, you got more, more investments than you do debt. The other one is the income from your investments can be Christ. They can be something happened like a pandemic that influences the income for six months or 12 months or, or longer potentially government can change its tax rules. So that can influence franking credits and you know, what you get as a tax return channel towards it.

And then from your personal perspective, things like your own income or your ability to save and pour more off the home loan and then draw up and create that cycle. That could be something to consider. Home values is another one, the price of the home. If that went down, you borrowed up to 70% or that’s why maybe for some people it might be better at 60%.

For example, that is something that can shift and change. We saw with the global financial crisis. It was only for 12, 18 months, two years, but that does happen. And. Oh, so I guess probably the investments don’t grow in value too. So your loan ends up being greater than your portfolio. That would be very demoralizing for a lot of things.

Cool.

Terry: [00:38:12] Over the course of that timeframe, that’s very unlikely though. Over 20 years, we’ve never seen a period of 20 years where you’ve made no money in the stock market.

Ryan: [00:38:21] There’ll be some chaos beyond your portfolio, if that were true, that’s

Terry: [00:38:24] very up. It could be there for time. That’s true. But for the whole 20, that’s very unlikely.

And I think that’s, what’s really important when you hear these variables, you might be thinking or that sort of disqualify. I can’t deal with any of that. It’s really important to think about probabilities here, assign a probability for each, you know, what’s the likelihood we think that the interest rates are going to increase beyond, you know, the income from our investments within this timeframe.

What do you think that is by some information, what is the probability that income from our investments decrease at the same time? And you can start to put some logic to it because otherwise you’d just be kind of going from a fear place going. And that’s where I hear that stuff. And I go, well, yeah. You know, is that worth it?

Well, I think it’s really important to put some sort of numbers to it, to go, you know, what’s the lie we’ve heard of this

Ryan: [00:39:07] happening. Yeah, absolutely. And I also a quick caveat here. I’m not currently doing this, you’re not currently doing this. I will be doing this when the right time comes. Like we’re focused right now on, on building our own business, building up our portfolio and a house will come.

But until then, this is something that I’ve taken the time to understand, to know that that is a move that I will take, but I’m not doing it right

Terry: [00:39:26] now. Yeah. I’m not sure whether I will depends on how we end up. All right. So look, that was a pretty, in-depth sort of look at this and we wanted this to be a companion to the ultimate guide.

So again, I’m just going to keep referring you back to the guide, all of the data, all the numbers, all the numbers, all the workings in there for you. So if you want more of that data, definitely go there and do that. But the real point with this is, look, you don’t need to wait until you’re finished off your home to buy a passive income and build it.

If you’re comfortable with debt, you can use this debt recycling strategies to convert that consumer debt into investor debt and drastically accelerate your wealth. And you’ve just seen by how much. So we do have members in the program that are managing this themselves. You do not need to be a financial advisor to do it.

You just need to take the time to understand it, work your way through it. Don’t be in a rush. Map out all those contingencies think through it clearly, and you are able to do it yourself. You don’t have to be an expert. So again, I’ll just point you back to the guide on our website. Have a good look through that and, uh, look guys, that’s it hope you enjoyed this bit of a different episode, but we think it’s going to be useful for a few people in the audience that did sort of reach out and ask off the back of the last episode around useful debt and what to think about and how to use it.

So, yeah, like this episode and you’re liking the podcast as always do us a favor, invest in us. Why sharing and subscribing to the podcast so that each episode comes out, you’ll be in the loop. And also you can share this with other people that you think could get value. Just remember for those of you that got stuck.

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