Mortgage or super?
Australians have been taught for generations to buy a home, work your entire life, pay off your mortgage, then once you are debt free start thinking about retirement or turning attention to building up your super.
But with interest rates at record lows (with many having interest rates starting with a 2) and many super funds potentially offering a higher rate of return, what’s the right strategy in the current market?
At Newcastle Advisors, this is one of the most common questions our Newcastle Financial Planners receive.
Are you better off putting extra money into superannuation or your mortgage?
Which strategy will leave you better off for retirement?
Unfortunately, like most questions in financial planning, there is no simple answer.
When it comes to the super vs mortgage debate there, no two people will get the same answer (unless you are married of course hahaha – Dad joke), but there is a checklist to follow to see what’s right for you.
Home loan interest rate VS superannuation earnings/returns
Consider the interest rate on your home loan in comparison to the rate of return on your super fund. As banks follow the RBA’s lead in reducing interest rates (well most of the time), you may find the returns you get in your super fund are potentially higher.
At present, most Australians (who are still employed) are able to negotiate a home loan starting with a 2%. Whereas, most balanced super fund investment options (being 50% growth/ 50% defensive) have recorded returns of 6.60% per annum over the past 10 years.
Compound interest
Super is also built on compounding interest. A dollar invested in super today may significantly grow over time. Keep in mind that the return you receive from your super fund in the current market may be different to returns you receive in the future. Markets go up and down and without a crystal ball, it’s impossible to accurately predict how much money you’ll make on your investment.
The following graph illustrates the benefits of compound interest of a super fund, without making any contributions.
After tax mortgage repayments VS pre-tax contributions to super
Each dollar going into the mortgage is from ‘after-tax’ dollars, whereas contributions into super can be made in ‘pre-tax’ dollars.
For the majority of Australians saving into super will reduce their overall tax bill – remembering that pre-tax contributions are capped at $25,000 annually and taxed at 15% by the government when they enter the fund.
Example:
Consider the size of your loan & how long you have left to repay it
A dollar saved into your mortgage right at the beginning of a 30-year loan will have a much greater impact than a dollar saved right at the end (with 5 years or less to go).
The interest on a home loan is calculated daily
The more you pay off early, the less interest you pay over time. In a low interest rate environment many homeowners, particularly those who bought a home some time ago on a variable rate, will now be paying much less each month for their home.
Offset or Redraw facility
If you have an offset facility attached to your mortgage you can also access extra savings at call if you need them. This is different to super where you can’t touch your earnings until preservation age or certain conditions of release are met.
Don’t discount the ‘emotional’ or ‘mental’ aspect here as well. Many people we see may still prefer paying off their home sooner rather than later and welcome the peace of mind that comes with clearing this debt. Only then will they feel comfortable in adding to their super & building for their retirement.
In Summary
Before making a decision, it’s also important to weigh up your stage in life, particularly your age and your appetite for risk.
Whatever strategy you choose you’ll need to regularly review your options if you’re making regular super contributions or extra mortgage repayments. As bank interest rates move and markets fluctuate, the strategy you choose today may be different from the one that is right for you in the future.
At Newcastle Advisors, we recommend you seek advice from our Newcastle financial planners, to understand your options & to ensure you take advantage of the opportunities available.
Case Study #1 – Where investing in super may be the best strategy
Bruce & Betty are 55 years of age and each earn $80,000 pa
They currently has a mortgage of $320,000, which he wants to pay off before he retires in 6 years’ time at age 61.
Their current mortgage is as follows:
Mortgage $320,000
Interest Rate 3.00% pa
Monthly repayments (post tax) $2,300 per month
Bruce & Betty have surplus income and are considering whether to:
make additional or extra repayments to their home mortgage (in post-tax dollars) to repay the mortgage in 6 years, or
invest the pre-tax equivalent into superannuation as salary sacrifice and use the super proceeds at retirement to pay off the mortgage.
Assuming the loan interest rate remains the same for the 6-year period, they will need to pay an extra $2,150 per month post tax to clear the mortgage at age 60 (this equals $2,900 pre-tax income).
Alternatively, Bruce & Betty can invest the pre-tax equivalent of $2,900 per month as a salary sacrifice contribution into super. As they earn $80,000 pa, their marginal tax rate is 34.5% (includes 2% Medicare levy), so the pre-tax equivalent is $2,900 per month. This equals to $34,800 pa and after allowing for the 15% contributions tax, they will have 85% of the contribution or $29,580 working for their super in a concessionally taxed environment.
To work out how much they will have in super in 10 years, we’re using the following super assumptions:
The salary sacrifice contributions, when added to his employer SG contributions, remain within the $25,000 pa concessional cap.
Super is invested in 50% growth/ 50% defensive assets, returning a gross return of 3% pa income and 4% pa growth.
Assuming the assumptions remain the same over the 6-year period, Bruce & Betty will have an extra $190,000 in super. His outstanding mortgage at that time is $150,000, and after he repays this balance from his super (tax free as he is over 60), he will be $40,000 in front.
Of course, the outcome may be different if there are changes in interest rates and super returns in that period.
Case Study #2
32 year old Max and 30 year old Maxine are a young professional couple who have recently purchased their first home.
They’re both on a marginal tax rate of 39% (including the 2% Medicare levy), and they have the capacity to direct an extra $1,000 per month into their mortgage, or alternatively, use the pre-tax equivalent to make salary sacrifice contributions to super.
Given their marginal tax rates, it would make sense mathematically to build up their super.
However, they’re planning to have their first child within the next five years, and Maxine will only return to work part-time. They will need savings to cover this period, as well as assist with private school fees.
Given their need to access some savings for this event, it would be preferable to direct the extra savings towards their mortgage, and redraw it as required, rather than place it into super where access is restricted to at least age 60.
NEWCASTLE RETIREMENT PLANNING
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Visit our Newcastle Financial Planners at Level 1/142 Union St, The Junction NSW 2291.
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