Your mortgage or your super?
- Financial Planning
Is it better to put spare cash into your mortgage or your super? While many may have opinions on this question, the answer is rarely black and white and will vary from person to person. There are pros and cons on both sides of the argument, so the right decision for you needs to be based on a sober assessment of the facts and must take your personal situation and priorities into account.
To that end, let’s take a look at the benefits and drawbacks on each of the options.
Tax benefits of super
One of the major attractions of putting money into super is the potential deductibility of contributions. With recent legislative changes, this is now available to both employed and self-employed people. The attractiveness of tax benefits will be dependent on what marginal tax rate you are paying. The higher the tax bracket you are in, the greater the tax saving you will gain by contributing. These tax benefits are not available if you put your money into your mortgage.
Of course, deductible contributions will still incur a 15 per cent contribution tax when put into super, but this is generally a lot lower than your marginal tax rate, so the net benefit is still substantial.
Watch out for contribution caps
While the tax benefits are real, there are limits on how much you can contribute to super each year and you do need to be cautious that you don’t exceed contribution caps when you make extra contributions. Any contributions in excess of the limits will be taxed at your marginal tax rate and may also incur penalty tax rates, so make sure you have your situation checked out by a financial planner or accountant.
What return is your super earning?
Apart from the tax situation, you need to make a judgement call on the potential investment returns that your super fund will generate. Of course, it’s impossible to know what future returns will be, but take a look at average historical returns your fund has generated over as long a period as possible (at least 7 to 10 years) to get a feeling for what the potential might be.
The projected return can then be compared with the current rate you are paying on your mortgage. The amount that your super returns exceed your mortgage rate may influence your decision on which option is best – the greater the difference, the more attractive super will be.
Bear in mind, however, that returns on your super from year to year are likely to fluctuate a lot more that your mortgage rate ever will, so you need to keep a long-term view when comparing rates.
How important is future flexibility to you?
Possibly the biggest drawback with putting funds into super is that they are essentially locked in until retirement. Except for a few extreme circumstances you will not be able to withdraw from your super, whereas your mortgage may offer a redraw facility that lets you extract funds if needs change down the track.
You need to make your own judgement about whether having the flexibility to be able to access funds is important to you. This of course can be a double edged sword for some people because having easy access may mean that your funds get frittered away on whims and fancies, rather than being locked in for your long-term wealth creation.
Advantages of putting funds into your mortgage
When considering the benefits of putting extra funds into your mortgage, you need to be aware of your current mortgage balance, the interest rate you are paying, whether it is fixed or variable and the conditions surrounding making extra repayments (there may be penalties or costs for this). Having all the facts will help you make a balanced judgement on whether it is the best option.
In general, accelerating mortgage payments will result in reducing your overall interest expense over the life of the loan and will allow you to repay the loan sooner. You may feel that psychologically it is better to get the mortgage paid out and then redirect funds into other investments once you are mortgage free.
If you are approaching retirement, the idea of having your mortgage paid before you retire may also hold appeal and give you greater flexibility on what you can do with your super once you are retired.
Are there other priorities?
Apart from the specifics of your mortgage and your super, there are other factors that may come into play, such as whether you have easy access to an emergency fund for unexpected expenses. If you don’t, then establishing such a fund may be preferable to the super or mortgage option.
If you have other high interest debts, such as credit card balances with high interest rates, then these may also take priority over your super or mortgage.
Get some sound advice
There are obviously many issues to consider and the right answer for you will take some serious analysis. If you are hesitant about which way to go it may be wise to consult a financial planner who can help you assess the relative merits and make an informed decision in the context of your overall financial planning.
What do you feel is the best option for using extra funds? Share your opinions below.