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Mortgage vs super – Which should you put your extra cash towards?

It’s a common question but fortunately, by running the numbers and considering the pros and cons of each option, it can be a straightforward answer for most people.

Let’s assume you have an extra $500 a month, should you put it towards your mortgage or contribute it to super? What will grow your wealth the most? We’ve run some numbers to help illustrate the difference. Of course, everyone’s situation is different and if you’d like to discuss your particular circumstances get in contact with our office via [email protected] or call us on (02) 8814 7977.

Putting the money in super:

The assumptions:

 Base caseExtra $500 per month
Super balance$60,000$60,000
Investment return7% p.a.7% p.a.
Tax on earnings7% p.a.7% p.a.
Contribution tax15%15%
Investment fees0.85% p.a.0.85% p.a.
Inflation2% p.a.2% p.a.
Type of contributionN/ANon-concessional

Superannuation balance under the base case at age 60: $609,499

Superannuation balance with the extra contributions at age 60: $877,351

Putting an extra $500 per month into superannuation nets an additional $267,852 in today’s dollars at age 60.

Paying down the mortgage:

Now let’s compare against paying down the mortgage. The assumptions:

 Base caseExtra $500 per month
Starting loan amount$800,000$800,000
Loan typePrincipal and interestPrincipal and interest
Interest rate*2.61% p.a.2.61% p.a.
Loan term25 years25 years
Repayment frequencyMonthlyMonthly
Total interest paid$290,024$239,487

*Average interest for October 2020 according to Moneysmart.gov.au

This shows us that an extra $500 per month on your mortgage could save you $50,537 in interest over 25 years.

The results

By choosing to put the money into your superannuation overpaying extra off your mortgage, you could be $217,315 better off.

This makes it clear that if maximising your wealth is your goal than prioritising superannuation contributions over extra mortgage repayments is the way to go.

The massive difference in outcomes is due to the current record low interest rates and relatively strong performance of diversified, multi-asset portfolios.

Why not put the extra money into super?

So, why doesn’t everyone put their extra money into super? The most common reasons we hear from clients are:

  1. I don’t want to lock my money up until retirement
  2. I want to reduce my principal in case interest rates go up
  3. I want to be debt free / own my house

Each of these are valid concerns and your personal preferences will always come into play but let’s address each in general terms:

I don’t want to lock my money up until I retirement

It’s true that once money is in super you typically can’t get it out until you retire. However, setting up an investment outside of superannuation can give you a similar return as superannuation and you can access your funds at any time, typically within just 2-3 business days. The main downside compared to super is you’ll typically pay more tax, but even this can be minimised through tax-aware investments and structures.

I want to reduce my principal in case interest rates go up

In the above scenarios, we assumed putting all or nothing into each option. Well, there is no reason you couldn’t put 50% on the mortgage and 50% into super if this made you more comfortable. Alternatively, you could direct all your extra money to super or a personal investment while interest rates are low and then redirect those funds to your mortgage if interest rates start to rise. The main things to think about here is that it’s rarely all or nothing; you can almost always take some combination of each option and you can change your strategy as the world around you changes or your priorities change.

I want to be debt free / own my house

This is essentially a choice between saving 2-4% in interest versus earning anywhere between 4-12% p.a. over the long-term, depending on your risk profile. The big difference here is the interest on cash savings are virtually risk-free, guaranteed returns but the investment returns are not guaranteed and could go backwards.

Typically, we would expect a growth investment to outperform the interest on your mortgage over the long-term. So, what happens if you put your money into super and still have a mortgage when you retire? In the above scenario, once retired, you could withdraw enough funds from your super to clear your mortgage and still have excess funds that continue to provide an income for you in retirement.

In summary

Whether you pay extra off your mortgage or make extra super contributions, you’re going to increase your net worth in the end. In the current economic environment, we believe most people are likely to be better off if their excess money went into superannuation versus their mortgage.

Remember your financial strategy is flexible and can change. Just because you choose one option today doesn’t mean you can’t change to the other in the future or even take a combination of both.

If you’d like to discuss which option is best for you, send an email to [email protected] or call us on (02) 8814 7977 and a member of our team can let you know your next steps.

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