What Are the Effects of Rate Rises on Debt Recycling?

Rising interest rates make debt recycling more expensive to hold, but they do not make it unworkable.

The strategy gradually turns non-deductible home loan debt into investment debt, where the interest may be tax deductible. When rates climb, the cost of that investment debt climbs too. The question for a Carnegie homeowner is whether the plan still holds up at a higher rate, and that can be tested with a few numbers.

How Do Interest Rate Rises Affect Debt Recycling?

A rate rise increases the interest on both your home loan and your investment loan, so your debt recycling cashflow tightens on both sides. The part of the interest that is deductible may soften the hit on the investment side, but the home loan side gets no such relief.

The deduction is also never the full story. You still pay the interest first and claim part of it back at tax time, depending on your circumstances. Your accountant can tell you how much of a deduction applies to you, and no tax outcome is certain.

The other effect is on the investment itself. A higher borrowing cost raises the return your investments need to deliver just to cover the interest. Returns can rise or fall, so a debt recycling strategy carries market risk as well as rate risk.

A Carnegie Example: What a 0.50 Percentage Point Rise Costs

A 0.50 percentage point rise adds about $250 a year in interest for every $50,000 of investment debt. The rates below are illustrative only and are not current market rates.

Consider a couple in Carnegie who use $50,000 of savings to pay down their home loan. They then borrow $50,000 through a separate loan split and invest it in a diversified share portfolio. They hold the new split on an interest-only basis at an illustrative 6.75% p.a.

• Interest on the investment split: $3,375 a year, or about $281 a month.
• After a rise to an illustrative 7.25% p.a.: $3,625 a year, or about $302 a month.
• Extra cost: $250 a year, or about $21 a month.

On its own, that is manageable. The bigger pressure comes from their remaining home loan, which also rises with the rate and carries no deduction. So before they started, they kept a cash buffer in their offset account. Six months of interest on the investment split at 6.75% is about $1,688, and they set aside more than that.

When rates rose, the buffer covered the higher payments. They kept the strategy running and agreed to review it each year with their accountant and broker. Their investments could still fall in value, and they accepted that risk before they began.

Loan Structure That Keeps the Interest Deductible

A clear debt recycling loan structure uses a separate split for each purpose, so the investment interest can be identified and apportioned correctly. This matters more when rates rise, because the dollars at stake grow.

The ATO looks at what borrowed money is used for, not just what the loan is secured against. Interest on a further borrowing under a redraw facility is deductible or not depending on how the redrawn funds are used. If a loan mixes investment and personal purposes, the interest must be apportioned.

Offset accounts and redraw facilities behave differently. Withdrawing from an offset account is a withdrawal of savings, not a new borrowing, so it does not change the deductible proportion of interest on the loan. A redraw, on the other hand, is treated as a new borrowing, and the purpose of that borrowing decides the outcome. Redrawing for a holiday from a split that funded investments can taint that split.

The trade-off is that separate splits can carry extra fees or different rates, depending on your lender. An investment loan set up with the right splits from day one is far easier to keep clean than one fixed later.

Is Debt Recycling Still Worth It When Rates Rise?

Debt recycling can still suit you after a rate rise if you can cover the higher interest from your income and expect your investments to earn more over time than the borrowing costs. If you cannot meet both conditions, the strategy adds risk without a clear reward.

The main trade-off is that you are borrowing to invest, and borrowing amplifies losses as well as gains. If markets fall while rates rise, you owe the same debt against a lower portfolio value. The strategy also relies on discipline: the savings or surplus cash flow you would have used to repay your home loan are redirected, so your home loan balance falls more slowly in some years.

For many households, cash flow is a key consideration. A household with steady income and a solid buffer is in a different position from one stretched across a mortgage and daily costs.

Stress-Testing Your Plan Before You Start

Stress-testing means running your repayments at a higher rate than you pay today and checking you can still cover them comfortably. Lenders do something similar when they assess your borrowing capacity, so it is worth doing yourself too.

Start with your total loan, then add the planned investment split. Run the repayments at your current rate and at a rate a few percentage points higher. Our mortgage repayment calculator can do this in minutes, and you can see how your borrowing capacity shifts once a new split is added.

If your fixed rate is about to end, check the timing as well. A rate reset can change your numbers quickly, so look at your refinancing options before you commit new money to investing. Restructuring a loan can involve fees and may change your rate, so weigh those costs first.

If you already have a debt recycling arrangement, a loan health check can confirm your splits are still set up correctly and your repayments still fit your budget.

To talk through your own numbers, speak with the Carnegie team at Archbold Financial. Call one of our team or book an appointment at a time that works for you, and we will model your plan at a range of rates. Please also speak with your accountant about the tax side of any strategy.

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