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Debt Recycling: How Australians Are Turning Their Home Loan Into Wealth

Merit Financial Services · February 2026 · 6 min read

For most Australians, the family home represents their single largest asset — and their mortgage the single largest debt. Yet the interest on that mortgage is not tax-deductible. Meanwhile, interest on borrowings used to produce assessable income is deductible. Debt recycling is the strategy that bridges these two realities, systematically converting non-deductible home loan debt into tax-deductible investment debt.

What Is Debt Recycling?

At its core, debt recycling is a disciplined process of paying down your home loan and simultaneously re-borrowing the repaid amount to invest in income-producing assets — typically a diversified share portfolio. Because the new borrowing is used to generate assessable income (dividends), the interest becomes tax-deductible under section 8-1 of the Income Tax Assessment Act 1997.

Over time, the total debt stays roughly the same, but its character changes: non-deductible debt shrinks while deductible debt grows. The net effect is a lower after-tax cost of borrowing and, if the investment performs well, a growing pool of wealth outside the family home.

The Mechanics: Step by Step

1. Split your home loan into a main loan and a re-draw or separate investment loan facility. This ensures clear delineation — critical for maintaining the deductibility of interest.
2. Make extra repayments onto the home loan (or use available equity). This creates capacity to re-borrow.
3. Re-borrow the repaid amount into a separate investment loan split.
4. Invest the funds into income-producing assets — most commonly Australian shares paying fully franked dividends.
5. Use dividends and tax refunds to accelerate repayment of the remaining non-deductible home loan.
6. Repeat the cycle until the home loan is fully converted to deductible investment debt.

Why Dividends and Franking Credits Matter

Australian shares are particularly well-suited to debt recycling because of the dividend imputation system. When a company pays tax at 30% and distributes a fully franked dividend, the shareholder receives a franking credit representing tax already paid. For an individual on the 39% marginal rate (including Medicare levy), the effective additional tax on a fully franked dividend is only around 9%.

Better still, the franking credits combine with the tax deduction on investment loan interest to create a powerful cash-flow engine. The tax refund generated each year can be directed straight back onto the home loan, accelerating the recycling process.

How the Strategy Self-Services Over Time

One of the most compelling features of debt recycling is how it compounds. Each cycle produces:

• Dividend income (which pays down the home loan)
• Franking credit refunds (which pay down the home loan)
• Tax deductions on investment interest (which reduce tax payable, freeing cash flow)
• Capital growth on the investment portfolio (building long-term wealth)

As non-deductible debt falls and the investment portfolio grows, the strategy increasingly funds itself. In many cases, the home loan is eliminated years earlier than it would have been through standard principal and interest repayments alone.

Who Does Debt Recycling Suit?

Debt recycling is not for everyone. It tends to work best for individuals and couples who:

• Are on a marginal tax rate of 37% or higher (the higher the rate, the greater the tax benefit)
• Have meaningful equity in their home (typically 20% or more)
• Have a stable income with capacity to service both loan splits
• Have a long investment time horizon (at least 7–10 years)
• Are comfortable with the volatility of share markets
• Have appropriate personal insurance in place

Risks and Considerations

Like any leveraged strategy, debt recycling amplifies both gains and losses. Key risks include:

• Market risk: Share prices can fall, potentially leaving you with an investment worth less than the debt used to acquire it.
• Interest rate risk: Rising rates increase the cost of both loan splits. Stress-test your cash flow at rates 2–3% above current levels.
• Liquidity risk: You need ongoing capacity to meet repayments even if dividends are cut during a downturn.
• Compliance risk: The ATO requires a clear nexus between the borrowed funds and the income-producing investment. Mixing loan purposes can jeopardise deductibility.
• Behavioural risk: The strategy requires discipline. Selling investments during a market downturn or using the re-drawn funds for personal expenses defeats the purpose.

It is essential to model the strategy thoroughly before committing, stress-testing against adverse scenarios and ensuring you have adequate buffers.

Getting Started

If you're curious whether debt recycling could accelerate your wealth-building journey, the first step is understanding the numbers in your specific situation. Factors like your marginal tax rate, loan size, available equity, and risk tolerance all shape the outcome.