For many Australians, the natural instinct is to use extra funds to reduce mortgage debt. This was particularly evident during the COVID-19 pandemic when additional savings were funneled into mortgage offset accounts. Paying off a mortgage provides security and peace of mind, but it may not always be the most effective strategy for long-term wealth building.

While reducing non-tax-deductible debt is beneficial, there may be more strategic ways to allocate extra funds that can enhance overall financial growth.

With property prices generally rising over the past 25 years, many homeowners have built substantial equity in their homes. Instead of focusing solely on paying off the mortgage, it may be advantageous to start directing savings toward wealth-building strategies such as investing in shares or contributing to superannuation.

One approach is to consider mortgage-to-property-value ratios. When the mortgage is less than 50% of the home’s value, surplus funds could be redirected towards investments. Alternatively, evaluating how much mortgage repayments consume of one’s net cash flow can provide a better indicator of financial flexibility.

For those in their 30s and 40s, building an investment portfolio outside of superannuation can provide greater financial flexibility, given that superannuation funds are generally inaccessible until age 60 or 65. Contributing the maximum concessional amount to super each year can keep the balance growing while allowing additional funds to be invested elsewhere.

For individuals in their 50s, it’s important to ensure that mortgage debt is under control before redirecting funds towards investments. By this stage, planning for retirement should take precedence, with strategies in place to clear any remaining mortgage debt before retiring.

Once the mortgage is manageable, leveraging home equity to invest can be a tax-effective strategy. Borrowing against home equity to invest allows for the interest on the investment loan to be tax-deductible, unlike interest on a primary home loan.

Strategies such as debt recycling and equity extraction can help homeowners use their property’s value to fund investments in shares or additional properties.

Debt recycling involves withdrawing cash from an offset account to pay down the mortgage, then re-borrowing the same amount to invest. This process turns non-tax-deductible home loan interest into tax-deductible investment loan interest while maintaining the same debt level.

Equity extraction involves increasing the mortgage to free up funds for investment. For example, increasing a mortgage from $1.5 million to $1.7 million and investing the extra $200,000 allows the interest on that portion to become tax-deductible.

Both strategies require careful structuring to ensure tax benefits are maximized and that the loan is clearly segmented between personal and investment debt.

Homeowners who have built up equity through rising property values may be more comfortable leveraging their home for further investments. However, those who have aggressively paid down their mortgage may have a lower risk tolerance and prefer more conservative strategies.

Borrowing to invest comes with risks, including potential job loss or market downturns. While investment loans can amplify gains, they also magnify losses. Homeowners should assess their financial stability and risk tolerance before pursuing this strategy.

Investing in property versus shares depends on individual risk appetite and financial goals. Property investment is often seen as more secure due to its tangible nature, but it lacks liquidity compared to shares. Selling a parcel of shares is quick, whereas selling a property can take months.

Property investment is also more capital-intensive due to expenses like stamp duty and maintenance costs, making it a longer-term commitment. Shares, on the other hand, offer flexibility and the potential for steady income through dividends.

For high-income earners, negative gearing—where investment property expenses exceed rental income—can provide tax benefits, but it’s essential to ensure the overall investment strategy is sound and diversified.

As retirement approaches, shifting from growth investments to income-generating assets becomes a priority. This transition allows individuals to fund their lifestyle while reducing exposure to market volatility.

Key strategies include:

• Selling growth-focused investments and reallocating funds to dividend-producing assets.
  
• Downsizing a home to pay off any remaining mortgage debt.
  
• Maximizing contributions to superannuation to benefit from its tax advantages.
  

The ultimate goal should be to enter retirement debt-free, with a diversified investment portfolio capable of generating sustainable income.