Debt Recycling

Debt recycling summary: 

• Most commonly, debt recycling is a way to borrow against your home equity and use that extra cash to invest in stocks or other assets.

• People who consider debt recycling tend to have healthy income and lots of home equity. 

• Debt recycling can carry some significant risks. 

Debt Recycling Definition and Meaning

If you own a home and have built up some home equity, it might feel like you've got an invisible bank account you can’t spend. 

What if you could use your home equity to buy other investments that help you build wealth? This investment strategy—borrowing against your home equity with a home equity loan or line of credit (HELOC) to buy other investments—is also known as debt recycling. 

It’s a financial strategy to purchase investments by replacing or "recycling" your non-tax-deductible debt with tax-deductible debt.

Debt Recycling: a Comprehensive Breakdown

Debt recycling is a financial strategy that involves borrowing against an asset like your home and using the money to buy investments that (ideally) generate income and increase in value.

A common way to recycle debt is to take out a home equity loan or line of credit against your home. You'd use the loan proceeds to invest in assets like real estate, income-generating rental properties, or stocks and bonds.

You might use the income from those investments to pay off your home mortgage faster. That increases your home equity. You might choose to borrow again and buy more income-earning investments, growing your wealth over time. That's where the term debt recycling comes in, because some people do it over and over.

In the short term, people use debt recycling knowing they’ll increase their total debt. The hope is that they will grow their wealth in the long run. 

Debt recycling is best for people who have great credit and can qualify for a low-interest home equity loan or HELOC. It can also be a good fit for people who have built up substantial home equity by paying off their mortgage faster. But for many other people, debt recycling could be too risky or expensive. 

Even though it has debt in the name, debt recycling is not a debt pay-off strategy or a method to get out of credit card debt faster. It’s an investment strategy. All investments come with some risk. Debt recycling is typically used by people with high incomes and larger amounts of home equity—those who can afford to take some risks with their money. 

Real-Life Examples of Debt Recycling 

Let’s say you own a home that is worth $500,000 and you owe $200,000 on the mortgage. That means you have $300,000 of home equity. Your bank is willing to give you a $100,000 home equity loan at 6% interest. 

Now you have an extra $100,000 of cash that you can invest. Here are some of the risks of this debt recycling/equity extraction plan: 

• Your investments might not outperform your home equity loan interest rate. Investment returns are never guaranteed. Stock values could go down, as well as up. If you’re borrowing at 6% to 7% just to earn 8% (or less), this might not be worth the effort.

• Interest rates might rise. Home equity loan interest rates are typically fixed, but many home equity lines of credit (HELOCs) carry a variable interest rate. 

• Your loan payments will increase. Home equity loans and HELOCs require repayment. Would your investments earn enough to help you repay the loan with interest? If the stock market is going up 20% per year, then perhaps. But not every investment is so immediately profitable.

• Your investment could lose value. Even if your investment flops, you still have to repay the loan.

Debt recycling carries risk. People who use this strategy successfully have a strong, steady income and enough home equity left to provide a safety cushion.