Module Four Debt Recycling

Module Four

Debt Recycling

Good Debt VS Bad Debt

VS

GOOD DEBT ? Income producing

? Tax Deductible

BAD DEBT ? Not income producing

? Not Tax Deductible

Credit Cards



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Credit Cards

It's very simple, Credit Cards allow your clients to spend money they DON'T HAVE!

Credit Cards are Financial Quicksand

If you see a client with a $10,000 credit card debt this should be alarm bells for you - It says they have spent $10,000 more than they earnt. They need Money Management and Cashflow Coaching!

At Crown Money Management, we have a fetish for cutting up Credit Cards. It is a truly freeing experience for our clients... you should give it a go with yours!

Car Loans

If you buy a new car, every time you drive it you should roll down the window and throw a $100 note out ? this is how much you lose just in depreciation! Cars lose on average 70% of their value in the first 4 years.

Most car accidents happen on the showroom floor. Pretty much the dumbest finance decision you can make is BORROWING to buy a NEW car.

Never get into debt for a liability that is losing value, only for things that accumulate and grow in value. Drive the cheapest car your EGO can afford.

Novated leases = novated fleeces. Never buy anything that's sold to you on a tax deduction!

Consolidate

Step 1 - Consolidate all possible debts into your client's home loan

Why do this? ? Usually their home loan will be the lowest interest rate they'll be able to

obtain for funding, drastically reducing the amount they'll be paying in interest ? Consolidate down to one repayment instead of several, this is easier for your client to focus on

To Do This:? They will need to have equity in their current property ? They will need the income to service the higher debt

Note: If by increasing their home loan they will take their loan to value ratio over 80%, and therefore have to pay mortgage insurance, it's important to do a calculation to ensure the amount they will pay in mortgage insurance is not greater than the interest they will save by consolidating.

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Balance Transfer

Step 2 ? Do a Balance Transfer on any credit cards that can't be consolidated

Why do this? ? Some credit card companies offer 18-24month 0% Interest Rate offers on debt transfers

from other credit cards, allowing the client to solely target the principal on this debt To Do This:? They will need to apply directly with the credit card provider ? Once approved, the money will be transferred to the old credit card, bringing it to a $0

balance ? It is then the client's responsibility to CUT UP their old credit card, and close the facility

down ? It is important to then work out a plan with your client to pay off the balance transfer debt

before the 0% interest term expires. This is either done by setting up a regular monthly transfer to the credit card, or by accumulating those funds in the client's redraw on their home loan Note: It is ESSENTIAL that the client cuts up their old credit card. All too often we've seen a client go through with a balance transfer, then continue using their old credit card.

Cash Flow Index

Step 3 ? Implement a Cash Flow Index program

Why do this? ? It's essential to put into place a plan for paying off all debts that aren't the home loan! The

trick is to find the right "priority", to make sure the client's money is being used most efficiently To Do This:? Work out the "Cash Flow Index" for each of your client's debt ? Divide the loan balance by the monthly payment ? The debts with the LOWEST index are the least efficient, and should be paid off first. This will release the most amount of cashflow to put towards other debts the fastest ? Any debts with an index over 100 are efficient, and can be left where they are until all other debts are paid off Note: The Cash Flow Index is the most effective way of identifying the first debt to be paid off. The alternatives are "Debt Snowball" whereby you pay off the lowest debt first to create psychological momentum, and "Landslide" where you pay off the highest interest rate debt first to save interest.

Scenario

Most Efficient

Least Efficient

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I want to invest (but don't have the money)

The easiest way to build your funds under management is to use the equity in your clients' home, because most people don't have the cash!

DEBT RECYCLING - this is where you don't just pay off your mortgage but you recycle the debt and use it as an investment tool. It means using the difference between the amount your client owes on their mortgage and the value of their house to potentially reduce their mortgage at the same time as building a sizeable nest egg.

Owner Occupied debt is considered "Bad Debt" because it is not tax deductible, and earns you no income.

Investment debt is considered "Good Debt" because it IS tax deductible, and earns you income.

Debt Recycling

The easiest way to build your funds under management is to use the equity in your clients' home, because most people don't have the cash!

DEBT RECYCLING is where you don't just pay off a mortgage but you recycle the debt and use it as an investment tool.

It means using the difference between the amount your client owes on their mortgage and the value of their house to potentially reduce their mortgage at the same time as building a sizeable nest egg.

Many people think they have to pay off their mortgage before they can spare enough money to invest. The problem with this idea is that if you do that, it might take so long that you won't have enough time left for your investment to grow and mature. Your best ally with investing is time. This strategy can help you make the best of both worlds.

Benefits vs Considerations

? Starts the wealth creation process immediately, allowing for long term growth of investments

? Replaces non deductible debt with tax deductible debt on a regular basis

? Helps you reach your lifestyle goals faster

? Diversified investment portfolio outside the family home

? Takes advantage of dollar cost averaging into the market

? Liquid asset

? Increased risk due to exposure to market volatility

? Capital losses for geared investments are potentially magnified compared to nongeared strategies

? Due to the high level of debt, employment security is especially important

? Suitable for Balanced investors at a minimum

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Debt Recycling Diagram

"GOOD DEBT" Tax deductible

debt

Equity Investment Loan

Home Loan

"BAD DEBT" Non tax

deductible debt

As long as you are receiving a bigger return on your investment than you're paying in interest, then this is a smart financial strategy!

Case Study - Debt Recycling

? Take the total debt to 80% LVR max to avoid Mortgage Insurance ? Figures are estimates only

Do the numbers!

Do the numbers, make sure it's worth it for the client. Need to take into account the tax payable on the investment return.

You can potentially look to fix in interest rates to give a level of protection for the structure.

Leverage and the use of it is exceptionally beneficial if it's used over a long time, if it's used over a short time it's exceptionally dangerous!

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