Mortgage vs super: Where should you put your extra money?

It’s an age old question – are you better off putting extra money into your home loan or super? We look at how the numbers stack up and the pros and cons of each option.

So you have an extra $200 a month and are tossing up whether you should use that to pay off your mortgage faster or top up your super. Or maybe you are expecting a tax refund of a few thousand dollars and are curious whether you’ll get more bang for your buck by adding it to your mortgage or your super.

The Canstar research team has crunched the numbers for those two scenarios to give you an idea of what the potential impact would be. Of course these are just hypothetical scenarios and the numbers will vary based on your individual situation including your age, salary, your super balance, size of your mortgage and interest rates.

Adding an extra $200 a month

As the tables show a 35-year-old who added an extra $200 to their super each month would have $73,688 more in super at age 60 than they would if they had relied on just the super guarantee. If they added that money to their mortgage instead they would have improved their situation by $58,712. So based on these numbers adding to super gives this 35-year-old a better result. All figures are in today’s dollars.

Superannuation Retirement Balance Projection – Extra Ongoing After-tax Contribution
Base Scenario Extra $200 per Month
Starting Age 35 35
Average Gross Annual Income $86,237 $86,237
Average Starting Balance $51,740 $51,740
Average Annual Investment Returns 7.30% 7.30%
Account Balance at Age 60 (today’s dollars) $374,125 $447,814
Difference to Base Scenario at Age 60 $73,688
Source: www.canstar.com.au – 14/07/2020.  Based on a 35 year old with a starting balance of $51,740 per APRA Annual Superannuation Bulletin, starting gross annual income of $86,237.  Employer contributions are presumed taxed at 15%.  SG contribution amounts per Government announced rates.  Total extra contributions over 25 years equals a total amount of $60,000.  Investment returns assumed to be 7.30% p.a. (APRA Superannuation Bulletin, average 5 year annualised rate of return; June 2019).  Net performance deducts average fees of 1.11% p.a. based on products in Canstar’s database for a 35 year old, with a balance of $60,000.  Average life insurance premium of $189 (increasing with inflation each year) is assumed charged at the end of each year based on products in Canstar’s database for an average balance of $80k and age of 45 years old.  Account balance is displayed in “today’s dollars”, meaning the value is adjusted for inflation.  Please note all information on income, annual superannuations fees and performance returns are used for illustrations purposes only.  Actual returns and the value of your investment may fall as well as rise from year to year; this example does not take such variation into account.  Past performance is not a reliable indicator of future performance.

 

Impact of Extra $200 Contributed to Monthly Mortgage Repayment
Base Scenario Extra $200 per Month
Starting Age 35 35
Starting Property Price $500,000 $500,000
Annual Property Price Growth 3.67% 3.67%
Interest Rate 4.41% 4.41%
Equity at Age 60 (today’s dollars) $605,788 $663,960
Difference in Equity $58,172
Source: www.canstar.com.au – 14/07/2020. Total extra contributions over 25 years equals a total amount of $60,000. Average annual property price growth based on annualised property price percentage change over the past 5 years using ABS Residential Property Price Indexes, March 2020. Interest rate based on average variable, principal & interest, owner occupier loans in Canstar’s database, taken over the past 5 years to March 2020. Equity at age 60 is displayed in “today’s dollars”, meaning the value is adjusted for inflation.

Adding a lump sum of $2,500

If that same 35-year-old had added a lump sum of $2,500 to their super they would have boosted their super by $11,878 by age 60. But if they had added it to their home loan they would have increased the value of their equity by $4,042. As in the previous example adding money to super has produced a stronger result.

Superannuation Retirement Balance Projection – Extra After-tax Lump Sum Contribution
Base Scenario Lump Sum of $2,500
Starting Age 35 35
Average Gross Annual Income $86,237 $86,237
Average Starting Balance $51,740 $51,740
Average Annual Investment Returns 7.30% 7.30%
Account Balance at Age 60 (today’s dollars) $374,125 $386,004
Difference to Base Scenario at Age 60 $11,878
Source: www.canstar.com.au – 14/07/2020.  Based on a 35 year old with a starting balance of $51,740 per APRA Annual Superannuation Bulletin, starting gross annual income of $86,237.  Employer contributions are presumed taxed at 15%.  SG contribution amounts per Government announced rates.  Investment returns assumed to be 7.30% p.a. (APRA Superannuation Bulletin, average 5 year annualised rate of return; June 2019).  Net performance deducts average fees of 1.11% p.a. based on products in Canstar’s database for a 35 year old, with a balance of $60,000.  Average life insurance premium of $189 (increasing with inflation each year) is assumed charged at the end of each year based on products in Canstar’s database for an average balance of $80k and age of 45 years old.  Account balance is displayed in “today’s dollars”, meaning the value is adjusted for inflation.  Please note all information on income, annual superannuations fees and performance returns are used for illustrations purposes only.  Actual returns and the value of your investment may fall as well as rise from year to year; this example does not take such variation into account.  Past performance is not a reliable indicator of future performance.

 

Impact of Lump Sum of $2,500 Contributed to Monthly Mortgage Repayment
Base Scenario Lump Sum of $2,500
Starting Age 35 35
Starting Property Price $500,000 $500,000
Annual Property Price Growth 3.67% 3.67%
Interest Rate 4.41% 4.41%
Equity at Age 60 (today’s dollars) $605,788 $609,831
Difference in Equity $4,042
Source: www.canstar.com.au – 14/07/2020. Average annual property price growth based on annualised property price percentage change over the past 5 years using ABS Residential Property Price Indexes, March 2020. Interest rate based on average variable, principal & interest, owner occupier loans in Canstar’s database, taken over the past 5 years to March 2020. Equity at age 60 is displayed in “today’s dollars”, meaning the value is adjusted for inflation.

As the examples show with interest rates at record lows there is certainly a case for tipping more money into your super than your mortgage. That’s partly because the return you are likely to get on your super will probably be higher than the interest you are paying on your mortgage.

But it’s not necessarily that simple and there is no one-size-fits-all answer to this question. Both options have their pros and cons and a lot depends on your personal situation. Here are some of the things to consider when weighing up where to put your extra cash.

 

House Money Box
Source: Kaikoro (Shutterstock)

Paying extra into your mortgage

The pros

  • By making extra repayments on your home loan you could potentially save tens of thousands in interest and also pay off your mortgage much faster. Let’s say you have a $400,000 mortgage and are paying 3.5% interest your monthly repayments would be $1,796 (assuming a 30-year term). Pay an extra $200 a month and you’d save $44,736 in interest over the life of the loan and pay it off four years and 10 months sooner. In essence this frees up nearly five years of repayments (around $115,768, including the extra $200 a month) to invest, which you could then use to supercharge your super.
  • You may still be able to access your money if your home loan has a redraw facility or offset account attached to it. If you are using redraw make sure you find out if any fees apply and if there is a minimum or maximum amount you can redraw. It’s also worth noting that if your circumstances change your bank can shut down your redraw.
  • It might not be a financial benefit but many people may feel better knowing they have paid off their mortgage faster and they own their home outright.

The cons

  • Unlike with super there are no tax perks that come with adding money into your mortgage.

 

Paying extra into your super

The pros

  • Making extra contributions to your super will mean you will have more money at retirement. If you are 40 years old, earn $85,000 a year and currently have $65,000 in your super invested in the default option the MoneySmart calculator estimates you’d have $425,083 at age 67 based on just super guarantee contributions. If you were to add an extra $200 a month via salary sacrifice your estimated balance would increase by $77,113 to $502,196.
  • There may be tax perks that come with making additional contributions to your super. For example any before-tax money that you put into super is taxed at just 15% (as opposed to whatever your marginal tax rate is). You may also be able to claim a tax deduction if you make an after-tax contribution – something only introduced a few years ago. Jonathan Philpot, wealth management partner at HLB Mann Judd Sydney, offered this example: Say if you are earning $150,000 a year, your compulsory super contributions will be approximately $15,000 a year, so at the end of the financial year you could add a further $10,000 into your super account and claim a personal tax deduction for this. This will provide a personal tax saving of $3,900 (39%) on the $10,000.

The cons

  • You generally won’t be able to access your money until you meet a  ‘condition of release’ such as reaching your preservation age and retiring; reaching your preservation age and choosing to begin a transition to retirement income stream while you are still working or are 65 years old (even if you have not retired). You also never know when the rules around super may change so this may be different in the future.

 

Woman weighing up her options
Source: ESB Professional (Shutterstock)

What to consider when deciding where to put your extra money

There are a number of factors to think about when you are trying to figure out what is the best option for you. Here are some of the issues to consider.

Your age

Paying off your mortgage in earlier years may then allow you to make extra super contributions later with surplus cash flow when mortgage payments are reduced and income may have increased, director of WLM Financial, Laura Menschik, told Canstar. “Younger people are usually more likely to have increased expenditure over the years and may not want money tied up in super, while older people may be in a better financial position to have the surplus cash to top up super before retirement,” she explained.

How much you have already paid off your loan

“Generally people should focus on reducing their mortgage, particularly in the first few years,” suggested Mr Philpot. When you first take out a loan interest accounts for a larger proportion of your repayment than principal so the more you pay off earlier the less interest you’ll pay over the long term.

“A good goal to aim for is reducing the mortgage level to 50% of the home value before considering any other strategies with your money,” Mr Philpot told Canstar, although he pointed out this approach may not be for everyone.

“Some may wish to add more into super at an earlier stage, however one of the best investments you will generally make is owning your own home, so moving as quickly as possible through the debt repayment stage of life will then provide more time to start building wealth outside of the family home,” he explained.

When you’ll need access to your money

With money contributed to super, it may not be accessible, if required, before you meet certain conditions explained Ms Menschik. “If someone requires money before retirement, paying off the mortgage may be a better option, especially if there is a redraw facility, offset account or access to equity in the property,” she said.

Mr Philpot agreed. “Having an offset account attached to the home loan allows all savings to sit within the offset account, thus reducing the interest on the home loan but still providing the flexibility to be able to use funds for holidays and school fees, etcetera as they arise,” he said.

Interest rates

When rates are low adding money to super can be more beneficial than it would be when rates are higher. These days the rate on your home loan should be at most about 3.5% which is very different to only a few years ago when rates were closer to 7% said Mr Philpot. “With the reduced interest rate cost, the ‘hurdle rate’ of investing, on an after tax basis, has also been lowered. This makes superannuation a more attractive option to consider, as over the long term there is a good chance that your superannuation will achieve a rate of return, after tax, of greater than 3.5%,” he explained.

What makes you more comfortable

Do you like the idea of owning your home outright before you move on to other investments? “Sometimes it comes down to a personal comfort zone and satisfaction of knowing you own your own property outright. This can then be a building block to help finance other investments,” said Ms Menschik.

Or you may prefer to lock your money away if you think that having easy access to your savings may mean you’re more likely to spend it on unnecessary things. As Ms Menshik pointed out you could eventually use a lump sum amount from your super to pay off any remaining mortgage to ensure you have a debt-free retirement.

 

Main image source: paulaphoto (Shutterstock)

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