The idea of being mortgage free is very appealing and often a key financial goal for our clients. Paying off your home loan as quickly as possible to avoid paying excess interest can be a good strategy. However, there can be considerable tax savings made by contributing extra dollars into superannuation. The question is, how you should be optimising spare funds?
There are some reasonably complex variables to think through which is why there is considerable value in seeking professional financial planning and investment advice.
Which goal is most important?
Deciding whether to pay off your mortgage or invest in super will be influenced by your goals, tolerance for risk and earning capacity.
Many people just want peace of mind and there’s no doubt that being mortgage free is a great way to achieve that. Paying down your home loan quickly will minimise the spend on interest for sure, but it is not always a bad strategy to run the full term of your mortgage, provided you put those additional funds to good use.
If your goal is more focused on wealth accumulation and setting yourself up for the best possible retirement it is prudent to do some number crunching. These calculations should account for the tax savings that can be made by extra super contributions vs paying off your home loan quickly.
Do your sums
As a case study, let’s consider you have a 10-year, $500,000 mortgage with an interest rate of 5.7%. Keep in mind that figures would change as interest rates fluctuate over a 10-year period, but this is a starting point to demonstrate. Based on these figures the monthly repayments would be approximately $5,428 (principal and interest).
For simplicity we have also excluded the banking fees as they are always variable depending on the lender. At the end of the 10-year term of your home loan you would have paid approximately $151,108 in interest.
If you paid an additional $500 each month, you would pay the mortgage off in 8 years and 11 months and only pay $133,319 total interest – more than a year sooner which is $17,789 less interest.
As per the below table, our calculations indicate that the benefit of making additional tax-deductible super contributions is greater if you have a higher Marginal Tax Rate (MTR) If you are on a lower income, you would considerably benefit in making additional loan repayments.
For example, if you earn $150,000, your net benefit would be $2,965 higher in making concessional contributions to super. If you would do the same at an income of $50,000. The impact of making tax deductible contributions would not be as big and you would have negative impact of $7,824 as opposed to making additional loan repayments.
Consider your unique circumstances
First and foremost, it comes down to your appetite for risk and what you feel most comfortable with. Both strategies can help you increase your assets. It depends how aggressive you want to be and whether your goal is to reduce debt or diversify your wealth.
Your choices may also be impacted by your lifestyle and stage of life. If you are closer to retirement you will most likely make different decisions to someone in their early thirties.
Be sure to consider the tax implications of the investment, especially if you are earning an income from it. Certain investments will be eligible for tax deductions and higher income earners may also find that the higher tax rate makes it more appropriate to pay down their mortgage.
Get advice
The decision as to whether you should pay off your mortgage first or diversify your investments is not cut and dried. It is important to do the due diligence. This is where seeking professional advice is truly worthwhile. We can look at your unique circumstances including your appetite for risk, the tax implications, your time horizon, and your liquidity requirements – and we can do the sums to inform your decision and give you peace of mind. Get in touch. We have an experienced team of financial planners on the Sunshine Coast, Gympie, Brisbane and Ipswich.
In this case study we have made the following assumptions: •Start balance of $0 in super and bank accounts •Concessional contributions of $500 per month vs adding $500 per month to loan repayments •A ‘Balanced’ rate of return on superannuation •Income of $50,000 - $100,000 - $150,000 and $200,000 •Many factors may change the outcome of these projections and they should be used for illustration purposes only. This article is general in nature and does not consider your particular investment objectives, financial situation, or insurance needs; we therefore recommend you seek advice tailored to your individual circumstances before making any specific decisions.
- Past performance is no guarantee of future results
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