Should I boost my super or pay down the mortgage? It’s not what you might expect.
It’s common for Australians to focus on paying off their home loans, and then, once debt-free turning their attention to boost 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?
It's one of the most often asked questions of financial advisors. Is it preferable for clients to put additional money into superannuation or the mortgage? Which option will benefit them the most in the long run?
This is not as easy a question as it may seem and does depend on your particular circumstances. For example:
· What is your ultimate financial goal? Do you want to own your home at retirement and have $60,000 pa to live off in retirement?
· Where will you live in retirement and how much does a house cost in that area?
· Are you expecting an inheritance or lump-sum or do you plan to downsize your home to enable you to repay the mortgage at some point?
· How old are you now and when do you want to retire?
· What are your goals before retirement?
Once you determine your goals, then there are the financial assumptions to consider, such as:
· How much will your salary and expenses change over time?
· What will future mortgage interest rates be?
· What will future returns on super funds be?
These are all things that can be modeled up by a financial planner. We have tools that can forecast which would be the best outcome for you, based on your particular circumstances and the assumptions you feel most comfortable with.
Take a single home-owner on a salary of $120,000 pa plus super. They have a 25-year mortgage of $750,000 at 2.31% pa. They have $305 per month of after-tax savings ($500 per month before tax) to decide what to do with. Let’s assume a 4.0% income return and a 1.5% capital growth return in their super fund. By salary sacrificing the $500 per month into super, this person would own their home by age 65 and have approx. $100,000 more in super compared to paying the $305 per month off their mortgage and then directing the money no longer used to pay the mortgage into their super fund.
If we use the same example but with actual data for the last 10 years (eg an average mortgage rate of 5% pa and average super fund returns of 10% pa (6% income and 4% growth) then again, you would have been better off putting your savings into your super, than paying off the mortgage.
The difficulty is that the above results for the last 10 years were not easily predictable 10 years ago. I would have expected that the interest rate was higher and the super fund returns were lower and that the outcome would have been line ball.
So what does it all mean?
This is a decision that warrants careful consideration as it can make a big difference to you in retirement.
However, there are no one-size-fits-all answers and the result depends on future outcomes which are hard to predict.
Generally, if you are on track to repay your home loan by the time you want to retire and actual future returns from your super fund are higher than the actual interest rate on your mortgage (over the whole period) then mathematically you would be better off putting your savings into super rather than repay the mortgage.
However, predicting the future is very difficult and the above issues are not the only things to consider and so the best approach is to get good advice from a financial planner on what is right for you and your particular circumstances.
@Paul Barrett of Absolute Wealth Advisers is one of Australia's most experienced Private Wealth Managers. He is a financial expert in high net wealth divorce, estate management, and inheritance. Contact him here