Should you grow your super or shrink your mortgage?

30 March 2021

If you’re thinking of making extra monthly contributions toward your super, good for you! You’re on your way to making smart decisions that you’ll thank yourself for years down the road. 

However, if you own a home, you may be facing a difficult question: Should you contribute more money to your super, or pay off your mortgage faster?

This is a good dilemma to have, but a tough decision. On the one hand, you feel as though you should contribute as much as you possibly can to your super because, thanks to compounding interest, even a little bit goes a long way. On the other hand, paying off your mortgage feels like a race to the finish line. You may want to pay as much as you can every month so you can start reaping the benefits that much faster.

So, how do you decide? Let’s start by looking at the positives of each strategy.

Why pay off your mortgage quickly?

If you are a homeowner, your property is likely your most expensive asset. Paying off that loan will be a huge weight off of your shoulders. It will mean you have one less monthly payment to worry about, and you can redirect that money towards something else.

Finishing paying off the biggest loan you’ve ever taken out several years earlier than you thought you were going to might be reason enough to put your extra funds towards your mortgage. However, perhaps an even bigger incentive is that paying off your mortgage faster means you actually pay less for your home in the long run.

Because of interest, when you take out a mortgage for a home, you actually have to pay more for the home than the price you bought it for. Essentially, you are paying for the opportunity to take out a loan so large and the time it takes you to pay the money back.

If you bought a house for $500,000 with a $100,000 down payment, you will need to borrow $400,000 from the bank. Let’s say the bank approves your loan at a 3.5% interest rate. The amount of time you take to repay the loan in full will have a significant impact on the amount of total money you pay. For example:

  • If you pay off the mortgage in 15 years with a monthly payment of $2,860, the total cost of your loan will be $514,715.
  • If you pay off the mortgage in 20 years with a monthly payment of $2,320, the total cost of your loan will be $556,761.
  • If you pay off the mortgage in 30 years with a monthly payment of $1,796, the total cost of your loan will be $646,624.

In the above scenario, by paying off your loan in 15 years instead of 20, you would save $42,046. There’s a lot you can do with the money you’d save by paying off your mortgage early, including saving for retirement.

Why make additional super contributions?

Planning for your future is always a good idea. If you make additional super contributions, you are sacrificing a little bit in the present so that you will be better off years down the road. For many Australians, that is all the encouragement they need to make additional super contributions, but there are even more compelling reasons as well.

Compounding interest

The money in your super accrues interest. When your contributions grow, the dollars that you gain from interest also begin to accrue interest, and so on and so forth. Growth begets growth; money turns into more money.

To put this into perspective, let’s say you have $10,000 in your super and contribute $100 per month. Compounded monthly at 4.25%, your super will grow to:

  • $27,967 in 10 years.
  • $55,429 in 20 years.
  • $161,556 in 40 years.

Compounding interest is a way of making money without actually having to work more. Just by being strategic and starting early, you can finance the retirement of your dreams.

Tax benefits

We showed you how adding money to your super can help you grow your wealth — now let’s talk about how it can also save you money in taxes.

If you add to your super by salary sacrificing, the money enters your retirement fund before it is taxed at your marginal tax rate. Once it’s in your super, it can only be taxed at a maximum of 15%. Depending on your salary, adding money to your super could also reduce the amount you have to pay in taxes overall.

Additionally, if you add money to your super through a personal contribution, you could claim the addition as a deduction on your tax return. You may also be eligible to claim a tax offset when making spouse contributions, which is a great option for couples with different incomes who want to level the playing field when saving for their golden years.

How to make a decision

If you are faced with the tough decision of whether to direct more money toward your mortgage or your super, the good news is that both options will help you build your wealth and plan for your future.

One thing that may influence your decision is your age. If you are young and have plenty of time to build your wealth and pay off your mortgage, contributing to your super may be the right move for you. The younger you are when you start saving for retirement, the more risk you can afford to take and the more you can take advantage of compounding interest.

That being said, paying off your mortgage is important, too. Our financial planners can help you make the right decision and figure out how to prioritise your monthly payments based on your current financial situation and your goals.

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