Hands down the most common question asked in our recent ‘Women and Superannuation’ seminars for Department of Local Government and Communities is:

**“I have some extra income at the moment.
**

**Should I use it to pay off my mortgage**

or put it into superannuation?”or put it into superannuation?”

Spoiler alert: the mathematics is crystal clear on this one, which is why most financial advisors won’t hesitate to reply: “Put it in superannuation”. This fails to account for your emotions and stress levels, which aren’t nearly so clear-cut.

I’ve dedicated the following blog to answering this question, including detailed calculations. I hope you find it useful. If you’d prefer a Cliff Notes version, check out the video instead (or read on below for more details):

#MoneyQuestions – Superannuation vs. Mortgage

SUPER VS MORTGAGE | Hands down the most common question we were asked at our Women and Superannuation seminars for the Department of Local Government and Communities (DLGC) was whether we recommended putting extra cash into the mortgage, or boosting the retirement account.The math is clear, but the emotions aren't nearly so straightforward.Got a #MoneyQuestion? We'd love to answer it – send us a PM 🙂

Posted by Money School on Thursday, August 3, 2017

Let’s start with the maths.

# Mortgage vs. Superannuation: the mathematics.

Let’s take a typical scenario to use as a worked example: a 55-year-old with a mortgage balance of $200,000 and a remaining loan term of 10 years. Her costs have gone down, and she’s finding she’s got an extra $1,000 (before tax) per month available.

### Assumptions

To complete the calculations, we have to make a few assumptions.

We’ll use an** average interest rate of 5.5% **for the 10 year term. At the moment, you should be paying 4% or less on a mortgage for your home (if not, please stop here and immediately proceed to asking for discounts). Given rates are at historical lows and have been for some time, it is reasonable to expect that the rate will go up over that 10 years as the economy strengthens. Most banks will still use between 7 and 8% in their long-term calculations, which is reasonable over 30 years. Our timeline is shorter, so we’ll use the midway point between 4 and 7%.

We’ll use** average superannuation returns of 6%** after fees, taxes et al. This may seem low, but it’s reasonable in the current economic climate. As interest rates rise, we would expect returns to also rise. For now, we’ll err on the conservative side.

We’ll use a **top tax rate of 35%**. This depends on your income and so will be highly variable between individuals. This bracket is the $37-80k bracket, which is considered ‘average’ in Australia. If you’re wondering why it’s 35% and not the ATO-quoted 32.5%, that’s because I’ve added in the likely levies.

We will also assume that **any extra superannuation contributions come in under the cap**. If you’re earning $80k a year and your employer is making the minimum contributions, you’ll have around $8k a year going in already. The current cap is $25k before extra tax kicks in, so we’ll be well under that limit in this scenario.

### Mortgage base case

The current mortgage is $200k with a 10 year term. Using 5.5% interest, the minimum monthly repayment would be $2,171 per month.

If she stuck with minimum repayments, the mortgage will be paid off in 10 years, when she reaches 65. In total, she will have paid $260.5k to pay off the $200k.

### Mortgage with extra repayments

Of the $1,000 per month she has before tax, at a 35% tax rate she’ll receive $650 in her hand. If that goes into the mortgage each month, the repayments jump from $2,171 to $2,821.

With this boost, she’ll pay off the mortgage in 7 years and 2 months, making her age 62/63. To that point, she’s put in an extra $56k. Paying the mortgage off quicker saves money because less interest is charged, so instead of paying $260.5k, she’s paid $242.5k – a saving of $18k in interest.

She can now put the extra into her superannuation and earn 6% on it. For 2 years and 10 months that’s what she does, putting $850 a month extra into super (why $850? See the next section). At the end of that period, she’s added $29k extra to her superannuation, and that portion has grown to around $31.5k.

The interest saved is equivalent to earnings – it’s money she didn’t need to spend – so we’ll treat it as such.

Totalling up:

- She put $56k extra into her mortgage and $29k extra into superannuation ($85k total)
- She earned $18k + $2.5k on that money ($20.5k total)

### Putting it into superannuation

The major difference between these two scenarios is the amount of extra money she has each month to contribute. When taking it in her paycheck, she’s getting $650 in her hand. If it goes directly into superannuation, she’s getting $850 because the tax rate of 15% on super applies. That’s 30% more than taking the cash in wages, which is why the maths is a stand-out for this case.

By the time she would have paid off the mortgage (7 years and 2 months in), she would have contributed an extra $73k to superannuation, and made $18k on it.

By the end of ten years, she has contributed an additional $102k and it’s grown to $139k.

# Comparing the two scenarios

When using the extra money to pay off the mortgage, she received **$85k in capital and made $20.5k on it**.

When putting the extra money into superannuation, she received **$102k in capital and made $37k on it**.

This is why it’s so clear-cut. The tax advantage of superannuation makes a huge difference to your capital, and the power of compounding affects it exponentially.

This is why most financial advisors will advise putting extra money in your superannuation, then using the extra growth to pay off the mortgage when you retire and can take out a lump sum tax free.

# What gets missed: stress, changing rules and guaranteed earnings

No doubt about it, **knowing you own your home outright is a recipe for sound sleep**. Interest rate changes, unethical bank conduct and poor job security will no longer keep you up at night. You’ll be safe and secure in the knowledge that whatever else happens, you have a roof over your head.

That knowledge may well be worth taking a loss (which is what you do if you put the money into your mortgage rather than superannuation).

Secondly, **who the heck knows what the rules will be regarding superannuation in the future?** With growing government debt and no sign of an economic boom on the horizon, politicians are liable to hit impending retirees where it hurts. There may be a tax on your superannuation withdrawals, or restrictions on how big a sum you can withdraw at one time. There are absolutely no guarantees on this stuff.

Finally, please remember that the** 6% return on superannuation was a guess**. It is entirely possible that returns will be lower, or higher. We have no idea, and no crystal ball with which to tell in the long term what’s likely to happen our economy (though we can have a good guess at the next three years).

What we CAN be confident in is interest on your mortgage. You will be paying it. The sooner you pay off your mortgage, the less interest you will pay. That’s as close as I can get to a guarantee in this scenario. So, do you take the certainty, or the hopeful estimate?

# So, how do I decide between mortgage and superannuation?

This is where you have to get personal. Only you can decide what’s right for you, and it may well be that you are willing to take the loss to have certainty around your home. Or, perhaps the maths was so convincing that you’re going the superannuation route.

Either way, I recommend applying the “Sleep Well Test”, which is:

**Will you sleep well if you take that option?**

And remember, you can always do both. Perhaps you put some into super, and some into your mortgage. Or, you might change your mind in a year or two. Just make it a conscious decision.

# Addendum – Reader question: what about the mortgage money?

I love it when people ask questions, they catch me out when I’m wrong. Jess wrote in with this one:

*Quick question:*

*In the paying off mortgage scenario, once Jane Doe finished paying off her mortgage, her monthly surplus would actually be $850 plus $2,171, which is what she was paying towards the mortgage she no longer has. **Was this accounted for in these calculations, because for this to be a true comparison, it needs to be.*

By golly, she’s right.

I ran the scenario, and here’s what I got (you can see the original in the comments below):

### Updated numbers assuming mortgage money now goes to super

You are correct, Jess. She does have the extra $2,171 per month (post tax) from 7 years 2 months in, and that she would be free to put that into super. Good spotting 🙂

It starts to get a bit complicated because of tax caps, but let’s give it a whirl:

- $2,171 post-tax (if the rate is uniformly 35%) would be $3339 pre-tax per month
- With 15% tax, that’s $2,838 per month into super
- With the additional $850, that’s $3,688 per month available to go into super
- She’d hit her contributions cap 4.6 months in (assuming she’s still on minimum contributions of $8k per year, and obviously financial year timing would affect that). It’s rarely worth contributing more than your caps due to tax impact, so let’s assume she stops at her $25k cap.
- Hard to know what she’d do with the extra monthly $2,821 ($2,171 + $650) for the other 20.2 months, so we’ll leave that $57k out.
- Assuming she can spread it across 3 financial years, she can contribute an extra $51k to her super fund in that remaining 2 years 10 months.
- If she starts at month 1, she’ll turn it into around $56k ($5k earnings). You’d start at month 1 and put the max in until 4.6 months, so you got more compounding effect (rather than spreading it across the year).

In that case:

- her capital going in is $56k + $51k = $107k
- her earnings on those are $18k + $5k = $23k.
- she’ll own her home outright and have an extra $56k in super, paying her around $3,370 a year (if she takes the earnings instead of compounding them).
- theoretically she’s had an extra $57k in her pocket after tax, when she wasn’t putting extra into her super fund. Lovely to think it went into more assets, but will exclude that for this purpose.

So, now the two scenarios are:

**Mortgage first:**

- $107k capital in (plus $57k elsewhere – spent, invested, who knows)
- $23k earnings
- $56k extra in super, earning $3,370 per year

**Super first:**

- $102k capital in,
- $37k earnings
- $139k extra in super, earning $8,360 per year.

Now this is the crunch point.

In both cases, you have your mortgage paid off at retirement, so you own your home outright.

If you have $56k in super versus $139k in super, that’s a 60% drop in capital and therefore income at retirement. Remember, you don’t earn an income from your home. You’re better off from the maths perspective putting it in superannuation.

If you include the $57k that went in her pocket when she paid the mortgage first, at best she’s ended up with ~$113k in capital (ignoring any earnings on that $57k in the 2.8 years she’s had it). You’re still better off from the maths perspective putting it in superannuation.

It’s the power of compounding – waiting till Year 7 to start putting the extra in means you get 1/4 of the compounding time, which has an exponential effect. This obviously has implications for retirement lifestyle too, as less capital means less income.

Thanks for the comment, Jess!

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Interesting to see the numbers, thanks Lacey

You’re welcome Gillian 🙂

Quick question:

In the paying off mortgage scenario, once Jane Doe finished paying off her mortgage, her monthly surplus would actually be $850 plus $2,171, which is what she was paying towards the mortgage she no longer has.

Was this accounted for in these calculations, because for this to be a true comparison, it needs to be.

Thanks for your comment, Jess. That’s an interesting question. You are correct that she does have the extra $2,171 per month post tax from 7 years 2 months in, and that she would be free to put that into super.

It starts to get a bit complicated because of tax caps, but let’s give it a whirl:

– $2,171 post-tax (if the rate is uniformly 35%) would be $3339 pre-tax per month

– With 15% tax, that’s $2,838 per month into super

– With the additional $850, that’s $3,688 per month available to go into super

– She’d hit her contributions cap 4.6 months in (assuming she’s still on minimum contributions of $8k per year, and obviously financial year timing would affect that). It’s rarely worth contributing more than your caps due to tax impact, so let’s assume she stops at her $25k cap.

– Hard to know what she’d do with the extra monthly $2,821 ($2,171 + $650) for the other 7.4 months of the year, so we’ll leave that out.

– Assuming she can spread it across 3 financial years, she can contribute an extra $51k to her super run in that remaining 2 years 10 months.

– If she starts at month 1, she’ll turn it into around $56k ($5k earnings). You’d start at month 1 and put the max in until 4.6 months, so you got more compounding effect (rather than spreading it across the year).

In that case:

– her capital going in is $85k + $51k = $136k

– her earnings on those are $20.5k + $5k = $25.5k.

– she’ll own her home outright and have an extra $56k in super, paying her around $3,370 a year (if she takes the earnings instead of compounding them).

– theoretically she’s had an extra $57k in her pocket after tax, when she wasn’t putting extra into her super fund. Lovely to think it went into more assets, but will exclude that for this purpose.

So, now the two scenarios are:

Mortgage first:

– $136k capital in

– $25.5k earnings (plus $56k elsewhere – spent, invested, who knows)

– $56k in super, earning $3,370 per year

Super first:

– $102k capital,

– $37k earnings

– $139k in super, earning $8,360 per year.

Now this is where it gets tough. In both cases, you have your mortgage paid off at retirement, so you own your home outright. Even if you include the $56k that went in her pocket (I won’t hazard a guess at what the earnings on that could be), if you’ve paid the mortgage first you’ve ended up with $112k in capital, whereas if you put it in super and took the full 10 years to pay off, you’ve got $139k in capital. It’s the power of compounding – waiting till Year 7 to start putting the extra in means you get 1/4 of the compounding time, which is an exponential effect. This obviously has implications for retirement lifestyle too, as less capital means less income.

Thanks so much for that question Jess, that was fun! I might add this comment into the body of the blog in case anyone has a similar question 🙂

Thanks Lacey. I have decided the super first as a result of this and I will now sleep better at night as I understand compound interest.

Awesome blog.

CHeers Deb

That’s awesome Deb, thrilled to hear it. Elaine and Donna passed on your email feedback about the May seminar and we are absolutely thrilled to hear it’s been of use to you and your friend. Here’s to your financial future!

Do these calculations allow for all the current fees attached to superannuation accounts. My husband, my two adult children and myself are all with different funds and all of us are hit with so many charges every month.

What is your recommendation on Income protection and Life insurance within a superannuation policy. I am aware this will eat away at your superannuation but at the end of the day you don’t notice it gone and otherwise may not bother to have it.

Hi Natalie, thanks for your comment.

I’ve used an ‘after fees’ rate for the % return on capital – so it’s the return % minus fees %. I’ve used 6% as the net after fees in these calcs, which is the same as 7% return with 1% fees, or 6.02% return with 0.02% fees – the net difference is what matters.

Because the composition and fees of funds varies dramatically – between different super providers and across different investment options within each provider – it’s hard to include fees as an average. May I suggest watching this video, which is me presenting on superannuation on behalf of the WA State Govt in May. In it, I go through how fees are calculated and how that affects your returns: http://youtu.be/MU7WknVPVrU

Fees are the one thing you can control, so I highly recommend shopping around. I’ve seen the Barefoot Investor recommend the HostPlus balanced index fund with 0.02% fees, so maybe use that as a benchmark.

Re insurance: it’s a very personal decision because so much affects it (e.g. how much should you insure for? Do you really need either type of insurance? What would you leave behind if you died – debt, or assets? etc.) What I’ve noticed is that insurance rates are highly variable between providers. Even the industry funds that tend to have lower super fees (as a %) can hit you with whopping insurance premiums, thereby undoing all their good work. If you decide you do need life, TPD and income protection, Quotes and comparisons are the way to go – you may find you can get a better rate outside your fund and that it makes more sense financially to do it that way.

Hope that helps 🙂

I think a mix of the 2 is the best approach. Each persons approach will differ but in general make sure to put extra into the mortgage for financial security in the short term. No point having lots of money available in 20-30 years if you can’t feed your family and put a roof over their head. Once you get a buffer of 3-6 months you should then start looking at putting extra into Super but even then still pay extra into the mortgage. So for example if you have $500 left over each month put $250 in the mortgage and $250 into Super. Once you hit the concessional cap then just put the rest into the mortgage to pay it down.

This article is very useful . Thanks

I would like to know which is better – paying off mortgage or adding to super as an expat (non resident of Australia for tax purposes) living and earning in Dubai

I’m trying to understand the tax penalties for both and which is the better option of the two , or if there is another better option for me off shore

Thanks

Absolutely! You just answer every small businesses owner queries would be effective! Thanks for this informative and useful tips.

Hi

Thanks for the explanation. However, I still find it a bit confusing. To simplify

Are you able to tell me after 10yrs,

With scenario 1- mortgage balance will be $0. Superannuation balance -$ ?? Savings balance -$?? (as she worked an extra 2 yrs and 10 months )

with scenario 2 – mortgage balance will be $0. Superannuation balance -$ ?? Saving balance – (will be $0)

Thanks

Kind Regards

Eddy

Hi Eddy, thanks so much for your comment. Just a quick one to let you know I intend to answer this in detail, but mired in TEDxUWA speech prep at the moment! I’ll get onto it next week and comment again then. Best wishes, Lacey

Hi Lacey,

Very useful information and i appreciate your time.

My scenario is I am contributing into my super up to the maximum 25K pa (employer/employee) and at least for now have extra cash each fortnight.

What about paying extra lump sums into super (after tax) or into mortgage in that scenario?

Was considering splitting it between the two?

Cheers

S

Great post. Just a question though, if I am currently traveling and make no money in Australia, but I make small super contributions from my savings account, will this be an issue for the tax department?

Great information – thank you.

The only thing I’m not following is how in this example the mortgage is paid off just as quick (7 years and 2 months) in both scenarios? Or am I reading it wrong? Wouldn’t the mortgage not be paid off until 10 years in the extra into super scenario?

Thank you

Great discussion & thanks for your time Lacey in writing & responding on these.

I have a slight variation on the question given what I want to know is…

Am I better off putting extra money into an existing investment property mortgage or into Super?

Presently I like the flexibility of building a redraw facility through paying extra off the inv.mortgage but are concerned that I pay income tax on the money going into the mortgage, then if I sell property in future would pay tax again through capital gains.

Even if you don’t show an in-depth analysis would greatly appreciate a general rule of thumb on this. I suspect you’ll say better off putting extra into Super…just want my thought verified.

Thanks again,

Ben.

Hi Lacey, thanks for this! Does inflation affect either situation? Is the 6% earnings after inflation?

Thanks

Emma

Hi Emma, I haven’t included inflation in this exercise – it’s all nominal dollars.

Since mid-January 2020 I started to look Super balance daily. This is Balanced fund with $1240 monthly regular add:

* 18th Dec 2019 – $384k

* 7th Feb 2020 – $398k

* 13th Feb 2020 – $400k

* 19th Feb 2020 – $401k

* 21st Feb 2020 – $403k

* 25th Feb 2020 – $396k = -$7k drop

* 29th Feb 2020 – $384k = -$19k drop (Corona virus stock market starts dropping)

My points are:

a – people do not realise how super balance jumps up and down on a daily bases

Usually, they get print out 1 per year and they are happy because it is up unless

a recession

b – Is the timing of when to pay extra cash into typical balanced super important? For

example if you put extra $20k cash into super during a recession (around the bottom)

instead, the same amount while normal medium or peak? When playing stock it is clear

to do it when the stock cycle is low but in case of super I am not sure 100%

c – If you close to retirement age it could be risky to choose the mortgage option as 2008

wiped out 25% of the super balance

Just before COVID-19 struct I began salary sacrificing 5.5% ($259 fortnightly) of my salary into my superfund. My fund took a massive dip and has come back up again slightly – obviously not back to the pre-covid amount.

It is a waste of money salary sacrificing at the moment? Should I temporarily stop salary sacrificing and save my money? Or am I basically buying shares at a cheaper rate which I’ll benefit from in the long-term?

Hi Karen, what a fab question! Thanks for asking it here.

I can’t give you an answer as I’m not licensed to do so, but here’s some things to think about:

1. Can you do without that cash? If you don’t need the money, you might be better off keeping it going to super – especially given the tax advantages.

2. What would you do with the cash if it wasn’t going to super? Save it in your buffer fund – which can be a good idea if you don’t have much cash readily available in this uncertain environment? Invest it elsewhere? Spend it? If you think you’d spend it, you might be better off leaving it in super.

3. What do you think the economy will do? This is anyone’s guess in the short term (6-12 months) because we don’t know how deep the recession will go, or how long it will last. If you think it’s got further to drop, you could hold off on the extra for now, and plan to put a slug in when you think we’re near the bottom. BUT: picking a bottom is generally a fool’s errand. So you’ve got to be honest with yourself about when you’d put the money back in, and what conditions you’d want to see in the economy.

I don’t think it’s a waste of money over the long term – eventually, the economy will improve. It’s then more a question of how long you’ve got till retirement – a decade or more makes it low risk to leave money in super and keep adding to your balance.

My $0.02 only 🙂