Should I pay extra to my mortgage or contribute to super

We all have different lives, different goals and aspiration, different plans and different things appear to be important for us.

But although we all are so very different with different opinions and points of view, we can very clearly see a very common pathway through life, especially when it comes to achieving financial outcomes:

• The very first stage is when we are young and just starting out, after landing our very first job,

– some are immediately saving for a home deposit (this is a very small percentage of the young population though)

– some are immediately buying a fancy car with expensive loans- a terrible idea, just to impress friends or to have an “adrenaline experience”.

– others are just enjoying life with friends spending all the income on fun. Living from pay check to pay check will have dire consequences later.

• Then, the second stage of our life is when in most cases we start the family, we get married, have kids, buy the family home, have a mortgage.

– some people are still in the kids zone, living from pay check to pay check, either because they want to impress everyone around them, often over-extending their budget with loans: home-loan, car-loans, personal-loans for holidays or furniture, buy-now-pay-later schemes, credit cards, payments for private schools. I really don’t know how those families manage with such financial burden, no wonder people are stressed and exhausted.

– but fortunately, there is a big group of people, who grow up and take financial responsibility for their lives and their families. They live within their means, not overspending for “fun stuff” but being careful with the budget and meeting their financial responsibilities.

Each of those stages obviously is a big topic for discussion in their own rights and would benefit from proper financial coaching and advice.

And then we get to the third phase of our lives, when kids leave home and become independent financially.

And I think from the finance perspective, this is when your financial journey really starts and becomes exciting and with lots of possibilities, providing it is correctly planned.

Therefore, the third stage is when we continue working, your total income is your own, you can concentrate on finishing off your liabilities, commence property savings, invest into rental property, add to superannuation, plan how much you need to save for your future or upcoming retirement.

You can introduce tax management strategies; you can start a business you’ve always wanted. So as you can see, you have lots of choices.

But often too many choices create confusion and insecurity. And one of those situations is:

Should I pay extra to my mortgage, or should I add more to my superannuation?

So what is better, which strategy will give financially a better outcome – paying off the mortgage as soon as possible or contributing extra to super?

If you start googling this question, you will find the following:

• companies or people that are providers of either a product or a service or advice in the superannuation space, such as super funds, financial planners (yes most financial planners) are saying very convincingly, that investing into superannuation will give you a better financial outcome long-term. And they will prove it with calculations, spreadsheets and options comparisons, based on certain assumptions.
• generic articles from other sources, not related to the superannuation business usually believe that paying off the mortgage is a more secure option that provide a better outcome financially and emotionally.

So what is the answer? What should you do in this situation? Which option should you choose?

The problem is that there is no one correct answer. Why? As I mentioned before, we all are so very different, and we all want different things and different outcomes. We all see money differently and we all have a different understanding of financial risk and comprehension of the risk/reward outcomes.

But as a general rule:

• If you are on a higher income, investing extra into super as a salary sacrifice or your personal deductible contributions could be more beneficial. This is because concessional contributions are reducing your personal income tax, so the benefit is not only bigger savings in super with ongoing growth and income within your super account, but also additional tax savings on your personal income. If you want to fully understand concessional contributions, you have four videos to watch to learn:

Concessional contributions to super – what is SG?

Concessional contributions to super – Salary Sacrifice

4 reasons to make personal tax deductible super contributions.

Reduce tax through super. How much can you contribute to super?

• If your income is lower, hence the tax savings is not substantial, but you still have income surplus, then in most cases, extra repayments to your mortgage will be better. Financially it will bring more stability knowing that your home-loan will be paid off before you retire, but the most important part is the emotional feeling of security, control and ownership.

Obviously in either case, there are other factors to consider, interest rates payable on mortgages, the higher the rates, the more you should concentrate on reducing your loan and not paying extra interest.

But then there is an opposite argument as well, shouldn’t I pay extra to my mortgage while interest rates are low. Any extra funds paid, will reduce my principle loan much faster, therefore if later a higher interest rates environment comes, the loan’s principle has already been reduced and the loan will cost less.

But what about if we are in the phase of growing economy, and share market, superannuation, all investments are growing dramatically, why not invest more and take advantage of the situation.

As you can see, you can argue any case.

So I think you should simply follow this logic:

• only worry about thigs that you can control, don’t second-guess and only apply to your finances strategies with the outcome that is known and predictable,
• be flexible with your strategy and adjust as your circumstances change.

We always need a solid financial plan, but because life is not numbers on a spreadsheet, you need to review, adjust and update your plan as you go and as your life changes.

So let’s look at this comparison:

Let’s meet Jenny and Steve a married couple both aged 55, with planned 10 years till retirement. Jenny’s gross income is $70,000, while Steve earns $150,000. They also own a family home of the value $1.5Mil with outstanding mortgage of $400,000. Steve has $500,000 in super, while Jenny has $250,000.

Scenario 1: They concentrate on mortgage repayments:

Steve’s tax is – $40,567 (tax rate 37%), Net income – $106,433

Jenny’s tax is – $13,217 (tax rate 32.5%), Net income – $55,383

Total Net Income for living = $161,816, Annual living expenses = $60,000 plus mortgage repayments

They have just negotiated their home loan for the 25 year term at 5% with minimum monthly repayments of $2,338, which equals to $28,056pa.

Their income surplus then equals to $73,760, therefore they decided to make extra $5,000pm mortgage repayments, which will reduce their mortgage from 25 years down to 6 years with interest saved of $246,827 over the 6 year period.

So at the age of 65 they do not have any mortgage and the total super balance is:

Steve $786,106 &

Jenny $472,459 – total both super funds $1,258,565

You might say it is a great outcome.

Scenario 2 – They maximise concessional contributions and then pay extra to mortgage:

Steve’s tax reduces to – $36,219 – tax savings of $4,348, net income – $99,250

Jenny’s tax reduces to – $6,668 – tax savings of $6,549, Net Income $42,185

So now their total net disposable income is $141,435

Their surplus income now amounts to $53,379

They want to leave themselves a buffer or $15,000pa in case they want to have a good holiday or require urgent funds, so they decided to make extra payment to the mortgage of $3,000pm

In this option, it will take 2 years longer to have the mortgage paid off and the total interest saved now is $220,998, which is a difference of $25,461 of extra interest paid in comparison to the previous scenario.

But what happens to their super balances at 65?

Steve’s total super is $882,611

Jenny’s total super is $572,994

They have $197,090 more in their super funds now then in option 1.

So if you compare this scenario, by implementing only salary sacrifice and paying extra to super, although reducing mortgage repayments, they will end up:

$197,090 better off in super

$25,461 loss – extra interest in mortgage

$108,970 tax saved over the period of 10 years between them.

So over the term of 10 year, at the age of 60 they would be $280,599 better off than just paying for the mortgage. That is a really compelling argument.

Obviously calculations are based on set figures:

– set mortgage rates for the term of the loan (I calculated based on 5%pa)

– set superannuation rate of return (I calculated based on 6.5% net of any costs)

This calculator and outcome will be different in every situation, depending on your gross income, value of your mortgage, total super balance, your age, your already set expenses, time till retirement, risk you are able to acceptable, and obviously the actual economy that will impact interest rates on your mortgage as well as returns on your super.

But there is another item that needs to be taken into equation, especially if you are on lower incomes than Jenny and Steve from our example, and that is Age Pension.

Each scenario will give you a completely different Age Pension outcome, and that needs to be taken into consideration from the start, and that is where financial advice with correct calculations is crucial.

But as I said before, in planning concentrate on what you know and what you can control and stop wishing or second-guessing.

So if you are in a similar situation than Steve and Jenny and you want to know the best option for you, feel free to organise the consultation with me

By: Katherine Isbrandt CFP®
Money Strategist & Retirement Planner
Principal of About Retirement