Mortgage versus super – a common dilemma
Conventional wisdom used to dictate Australians were better paying off their home loans, and then, once debt-free turning their attention to building up their super. But with interest rates at record lows and many super funds potentially offering a higher rate of return, what’s the right strategy in the current market?
One thing to consider is 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, you may find the returns you get in your super fund are potentially higher.
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.
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 $27,500 annually and taxed at 15% by the government (30% if you earn over $250,000) when they enter the fund.
So, with all that in mind, how does it stack up against paying off your home loan? There are a couple of things you need to weigh up.
1. Consider the size of your loan and how long you have left to pay it off
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.
2. 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.
3. Offset or redraw facility
If you have an offset or redraw 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’ aspect here as well. Many individuals may 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.
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 voluntary 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.