Debt recycling can sound intimidating when you first hear about it, but it is simply a repeatable process that thousands of Australian homeowners use to build wealth faster and pay less tax. This guide walks you through every single step in plain, formal English—so you can see exactly how it works from day one until the day you finish.
Step 1: Understand Your Starting Point
Before you begin, you need three things in place:
- A home loan with available redraw or a 100% offset account
- Some surplus income each month (even $500–$1,000 makes a difference)
- The discipline to invest rather than spend the money you withdraw
Most people already have the first two. The third is what separates those who build wealth from those who don’t.
Step 2: Set Up the Correct Loan Structure
This is the foundation. Almost everyone who succeeds with debt recycling uses a split loan:
- Loan Split A – Principal & Interest (P&I) – this remains your true “home loan” (non-deductible)
- Loan Split B – Interest-Only (IO) with redraw or offset – this will become your investment loan (deductible)
Many lenders (CBA, NAB, Macquarie, Westpac, ANZ) allow you to do this online or with a quick phone call.
You can start with 100% in the P&I portion and gradually move money across as you progress.
Step 3: Pay Extra into the Non-Deductible Loan or Offset
Every extra dollar you pay into the P&I split (or park in the offset account) does two things:
- Reduces the non-deductible debt
- Instantly creates accessible equity
Example: You pay an extra $10,000 off the principal. Your loan balance drops by $10,000 and you now have $10,000 available to redraw.
Step 4: Withdraw the Exact Amount You Have Paid Off
This is the critical step. You withdraw only the principal you have repaid—no more, no less.
Why the precision matters: The ATO allows interest deductibility only on money that is clearly and solely used for income-producing purposes. Mixing amounts destroys the tax claim.
Keep a simple spreadsheet or “loan purpose register” showing:
- Date of extra repayment
- Amount repaid
- Date of withdrawal
- Exact investment purchased
Step 5: Immediately Invest the Withdrawn Funds
The moment the money lands in your bank account, transfer it to your brokerage account and buy income-producing assets.
Popular beginner choices:
- Vanguard Diversified High Growth Index ETF (VDHG)
- A200 or IOZ (ASX 200 index ETFs)
- Established Listed Investment Companies (LICs) such as AFI, ARG, or BKI
The assets must produce assessable income (dividends/distributions) for the interest to be deductible.
Step 6: The Interest Becomes Deductible
Because the borrowed money was used exclusively to purchase income-producing assets, the interest on that portion of the debt is now 100% tax-deductible.
Your lender will usually provide a loan statement showing interest charged on each split. Your accountant allocates the correct interest to your tax return.
Step 7: Repeat the Cycle Regularly
Most people repeat Steps 3–6 every 3, 6, or 12 months.
Each cycle converts another slice of bad debt into good debt and adds to your investment portfolio.
Over 15–25 years, this compounding effect is extraordinary.
Step 8: Manage the Interest-Only Portion Correctly
As your deductible debt grows:
- Keep the investment split on interest-only (no principal repayments required)
- Continue smashing extra repayments into the non-deductible P&I split or offset
- Never pay down the investment loan unless you are selling the assets
This keeps your cash flow strong and maximises tax deductions.
Step 9: Handle Lump Sums the Smart Way
Bonuses, tax refunds, or inheritances can turbo-charge the strategy.
Example: You receive a $50,000 inheritance.
- Pay it straight into the offset or P&I loan → reduces non-deductible debt
- Immediately redraw $50,000 and invest → converts it to deductible debt in one move
Step 10: The End Game – Crystallising the Wealth
When you are ready (often in retirement or when the family home is sold):
- Sell the investment portfolio (pay any CGT – usually at the 50% discounted rate)
- Repay the entire investment loan
- You are typically left with little or no remaining home loan and a large pool of capital
Many people then buy an annuity, reinvest conservatively, or purchase their retirement home outright.
Real-Life Timeline Example (Average Family)
Year 0: $600,000 home loan, all non-deductible
Year 5: $300,000 non-deductible + $300,000 deductible (and $300,000 in shares)
Year 12: $100,000 non-deductible + $700,000 deductible (and $700,000+ in shares)
Year 20: $0 home loan remaining + $1.2m–$1.8m investment portfolio
All built from normal salary, without lifestyle sacrifice.
Essential Record-Keeping Requirements
The ATO is increasingly focused on debt recycling. Protect yourself by maintaining:
- A loan purpose spreadsheet (date, amount, purpose, investment bought)
- Bank statements showing the exact flow of funds
- Brokerage confirmations timed immediately after each withdrawal
- Annual letter of advice from your accountant confirming deductibility
Conclusion
Debt recycling is not complicated—it is simply a disciplined, repeatable ten-step process that turns your largest household expense (your mortgage) into your most powerful wealth-creation tool.
When executed correctly and patiently, it is one of the few completely legal strategies that can save Australian families hundreds of thousands of dollars in tax while simultaneously building a seven-figure investment portfolio.
At Stickman Wealth, we guide clients through every one of these steps with clear loan structuring, ATO-compliant documentation templates, and conservative, low-cost investment portfolios designed to stand the test of time.
