In this guide
It’s a common question that arises when people have money they can afford to save and want to make the most of it. Is it better to pay down my mortgage or make extra contributions to super and boost my retirement savings?
Answering this question, like many things in life, is not simple.
The option that is most likely to leave you financially better off depends on several factors:
- How your mortgage interest rate and super investment returns are expected to compare in the long term
- Your income (and income tax bracket)
- How much space is available for you to make tax-deductible contributions to super under the concessional cap.
Of course, any decision involving your home is unlikely to be purely financial. Repaying the mortgage may give you a sense of emotional security or the freedom to move on to a larger property or renovate.
Mortgage interest vs super fund returns
When you make additional mortgage repayments or save in a mortgage offset account you’re effectively ‘earning’ the interest rate attached to your mortgage on your savings.
When making a choice between saving in super or towards the mortgage, it’s natural to compare the interest rate on the mortgage with the likely investment return from your super. Both your mortgage and super are long-term savings vehicles, so the average return over a long period of time is important.
At the time of writing, the average standard variable interest rate is around 6.55%. The long-term historic average is hard to come by, but according to the Reserve Bank of Australia (RBA) the five-year average to June 2024 was 4.06%. If you think mortgage interest rates are likely to fall from their current highs, then you may need to factor this into your calculations.
The returns from super have also been relatively high recently, and substantially higher than mortgage interest rates. According to Chant West, in the year to June 2024 the average return from Growth funds (61–80% growth assets) was 9.1%. The average annual return over five years was 6.3% while the return over 10 years was 7.2%.
While history can’t tell us what will occur in future, it can give us information about trends.
The investment strategy you have chosen for your super will also affect the likelihood that your super return outpaces your mortgage interest rate. More conservative options with lower exposure to growth assets like shares and property have a lower long-term return while more growth-oriented options are more likely to experience a return higher than mortgage interest rates.
If your contributions to super will be non-concessional (after tax), the only way saving in super can leave you better off financially is if your super return is higher than your mortgage interest rate. However, if you can make concessional contributions, the picture changes thanks to tax savings.
Tax savings
If your marginal tax rate is higher than the 15% contribution tax for concessional super contributions, you can reduce income tax by making concessional super contributions. The higher your income, the greater the tax savings, but everyone earning more than $45,000 may benefit.
Reducing the tax you pay increases the amount you can afford to contribute to super vs the mortgage, for the same cost to your after-tax income.
When making concessional contributions to super, it is important to be mindful of the concessional contribution cap. Contributions above the cap do not generate a tax saving because they are taxed at your marginal rate.
If you are an employee, remember that contributions your employer makes for you are counted in the cap. If you’re a high-income earner, you may not have much room to make additional contributions on top of what your employer pays.
Lastly, if your income plus concessional super contributions exceeds $250,000 for the financial year, additional tax applies to your concessional contributions – Division 293 tax. This reduces the tax saving from concessional contributions but does not eliminate it. People with income at this level are liable for 47% income tax (including Medicare) and pay a total of 30% tax on concessional super contributions – generating a tax saving of 17% from concessional contributions that are under the cap.
Why choose the mortgage?
While the competitive return of super and the tax savings available make it attractive, the biggest pitfall is that it is preserved until you retire or meet another condition of release.
The clear advantage of making additional mortgage repayments or saving in your mortgage offset account is flexibility. Additional mortgage repayments can generally be redrawn if needed and the funds in an offset account are always accessible.
If circumstances change, the saved funds can be used for other expenses.
For younger people, super may be unattractive because of the length of time savings will be locked away, even if it would make sense financially.
Perhaps you have a short-term savings goal like a dream overseas trip. Accumulating those savings in a mortgage offset account would reduce your interest charges while you save and withdrawing the money later to pay for your trip would be simple. Saving in super would not allow you to achieve this goal – unless the holiday is taken after retirement!
You may just feel more comfortable knowing that your mortgage is paid down as much as possible. Some of us feel safer when debt is minimised, particularly when interest rates are high.
Maybe you have additional income you can save now but are worried about affording mortgage repayments if interest rates were to rise in future or when your fixed-rate period ends.
Directing your savings towards mortgage offset to build a buffer zone could make more sense than saving in super. This way, if your mortgage payments rise you can draw from the savings to help meet the increased cost.
Another consideration is that to achieve an investment return from super that is competitive with your mortgage interest rate you will need to accept some risk of short-term negative returns. By choosing your mortgage offset account or additional repayments, you can lock in a risk-free and tax-free return.
Case studies
It is important to note that all modelling relies on assumptions. The outcome will vary if real-life circumstances are different.
The examples below have been modelled using Moneysmart’s compound interest calculator (interest compounded annually) and a mortgage amortisation calculator using a mortgage interest rate of 6% and super return of 7%. The super return used is broadly reflective of the 10-year average for Growth super investment options after investment fees and tax.
They are simple illustrations only and do not consider the impact of super administration fees, mortgage fees or the variability of super investment returns. Estimates have not been adjusted to account for inflation and assume salaries, tax rates and contribution limits remain static throughout the modelled period.
The bottom line
Deciding whether to make additional super contributions or extra mortgage repayments can be a difficult and personal choice.
If you have space under the cap to make concessional contributions, super is an attractive option thanks to the income tax saving that allows you to save more without increasing the impact on your hip pocket. However, if you have a low income, the tax saving from super contributions may be small or there may be no saving at all.
If you can’t reduce tax with concessional contributions, either due to low income or because you have reached the contribution cap, super is a less attractive prospect but could still leave you better off if the investment return is likely to be higher than your mortgage interest rate.
Of course, money that you contribute to super is preserved for your retirement. If you can’t give up access for that long, saving via the mortgage is a more obvious choice. You may also simply have personal or emotional reasons for choosing the mortgage – the security of knowing you are minimising debt or plans to use that extra equity to renovate.
A frequent compromise is to make the best of both worlds. Why not consider additional savings towards both mortgage and super?
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