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

2025-11-23

AI Summary

This study examines the feasibility of homeowners’ debt recycling strategies—leveraging home equity to invest while accelerating mortgage repayment—under the tax and regulatory regimes of Australia, Germany, and Switzerland. We develop a dynamic debt recycling model integrating interest tax shields, borrowing costs, and mortgage rates, formalized via differential equations to capture household balance sheet evolution. The model is calibrated and simulated using country-specific parameters. Our key contribution is the first endogenous incorporation of the interest tax shield into the debt recycling theoretical framework, revealing its critical moderating role on strategy viability: in the absence of tax shields, positive interest rates substantially narrow the profitable parameter space and extend repayment horizons; conversely, tax shields meaningfully reduce effective financing costs, rendering investment in rental property—where interest deductibility is widespread—consistently superior to owner-occupied investment. The analysis systematically links institutional heterogeneity to performance divergence, offering rigorous foundations for household financial decision-making and policy design.

Technology Category

• Game Theory and Economic Paradigms: Mechanism Design
• Multiagent Systems: Mechanism Design
• Search and Optimization: Other Foundations of Search & Optimization

Application Category

• Economics, Online Markets and Human Computation: The sharing economy
• User Modeling, Personalization and Recommendation: Accountability, Transparency, and Ethics for personalization
• Graph Algorithms and Modeling for the Web: Efficient manipulation of static and dynamic Web-related graphs

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.

Problem

• Modeling debt recycling viability under varying fiscal regimes
• Analyzing tax shield impacts on borrowing costs and equity
• Comparing mortgage strategies across international interest rate environments

Innovation

• Model integrates mortgage rates and tax shields
• Framework calibrated across three diverse jurisdictions
• Quantifies tax shield impacts on repayment efficiency