A calibrated model of debt recycling with interest costs and tax shields: viability under different fiscal regimes and jurisdictions

TL;DR

This paper develops a model of debt recycling incorporating interest costs and tax shields, analyzing its viability across different countries with diverse fiscal regimes and interest rate environments.

Contribution

It introduces a novel framework for modeling equity and mortgage dynamics considering interest rates, borrowing costs, and tax shields, calibrated to multiple jurisdictions.

Findings

Positive interest rates without tax shields hinder success regions and extend repayment.

Tax shields reduce effective borrowing costs and boost equity through interest deductibility.

Rental properties outperform owner-occupied housing due to tax shield advantages.

Abstract

Debt recycling is a leveraged equity management strategy in which homeowners use accumulated home equity to finance investments, applying the resulting returns to accelerate mortgage repayment. We propose a novel framework to model equity and mortgage dynamics in presence of mortgage interest rates, borrowing costs on equity-backed credit lines, and tax shields arising from interest deductibility. The model is calibrated on three jurisdictions -- Australia, Germany, and Switzerland -- representing diverse interest rate environments and fiscal regimes. Results demonstrate that introducing positive interest rates without tax shields contracts success regions and lengthens repayment times, while tax shields partially reverse these effects by reducing effective borrowing costs and adding equity boosts from mortgage interest deductibility. Country-specific outcomes vary systematically, and rental properties consistently outperform owner-occupied housing due to mortgage interest deductibility provisions.