Many home owners are making the most of low interest rates and using available savings to put towards paying off their mortgage.
While you may think that reducing your home loan debt as fast as you can is a sound strategy, there could be better options for your long-term financial future.
If you are currently making more than minimum mortgage repayments and have some equity in your home, starting an investment plan and/or contributing to super may prove to be a better long-term financial strategy.
While paying off your mortgage does mean you are accumulating wealth and reducing debt, it does not provide you with a passive income. As you head towards retirement, it’s important to create a passive income stream that will replace your employment income when you retire. This will help you enjoy the retirement of your choice without needing to rely on the age pension.
Of course, you have the option of benefitting from any capital growth of your home by selling and downsizing when you retire, although this will incur selling costs and stamp duty when you buy again.
As an alternative, you could consider harnessing the power of compound interest, which can pay dividends when it comes to building your retirement savings. Even a modest capital investment can significantly build your wealth over time and the earlier you start, the more you’ll earn.
Waiting until you are debt free to start an investment plan may not be the best strategy for your long term financial benefit. In the examples below, we outline three different scenarios to highlight how starting an investment plan and/or contributing excess funds into super can stack up when it comes to building retirement savings and generating a passive income.
Scenarios
John is 45 years old and owns his home with $150,000 owing on his mortgage. He earns $90,000 per year and is currently paying $1,157 per month towards his mortgage (minimum repayment) as shown in the graph below [1]. John currently has $200,000 in super would like to retire at age 60, 15 years away.
Mortgage details
Amount borrowed: $150,000
Interest Rate 4.5%
Repayment Frequency: Monthly
Length of Loan: 15 years
Your repayments will be $1,157 per month
Interest component of loan $58,387
John is considering the following three options:
Mortgage details
Amount borrowed: $150,000
Interest Rate 4.5%
Repayment Frequency: Monthly
Length of Loan: 15 years
Your repayments will be $1,157 per month
Interest component of loan: $58,387
Increased mortgage repayments
Amount borrowed: $150,000
Interest Rate 4.5%
Repayment Frequency: Monthly
Length of Loan: 15 years
Increased repayments $2,000 per month
Interest component of loan: $27,511
Superannuation calculations
Age: 45
Income: $90,000 (before tax and super)
Desired retirement age: 60
Super balance: $200,000
Employer contributions: 9.5%
Additional contributions: No
Fund fees: Medium Fee Level, 0% contribution fee, $50 admin fees per annum, 0.6% indirect cost ratio
Investment options: Balanced, 4.8% investment return p.a., 7% tax on earning p.a., 0.5% investment fees
In this scenario. John pays an additional $850 (approx) towards his mortgage each month and pays off his mortgage earlier and saves $30,876 in mortgage interest by increasing his mortgage payments and will have $348,309 in super at the time of retirement at 60 years of age.
Option2: Making minimum mortgage repayments and building his retirement savings through superannuation through pre-tax super contributions as shown in the graph below [4].
Superannuation calculations
Age: 45
Income: $90,000 (before tax and super)
Desired retirement age: 60
Super balance: $200,000
Employer contributions: 9.5%
Additional contributions: $850 per month
Fund fees: Medium Fee Level, 0% contribution fee, $50 admin fees per annum, 0.6% indirect cost ratio
Investment options: Balanced, 4.8% investment returnp.a., 7% tax on earning p.a., 0.5% investment fees
In this scenario, John contributes an additional $850 each month into his super and maintains minimum mortgage repayments of $1,157 per month. While he will pay an additional $30,876 in interest payments, his super balance will be $138,411 more than if he had relied on Employer Super Guarantee Contributions only.
Option 3: Investing in a managed fund as shown in the graph below [5].
Investment fund calculations
Amount: $2,000
Invested for: 15 years
Additional contributions: $850 paid monthly
Investment earnings: 5.5%
Management costs: 2%p.a.
Other management costs: 0% p.a.
Contribution fee: 0%
Advice Fee: 0%
Superannuation is one of the most tax-effective schemes available with contributions and earnings generally taxed at just 15% (unless you earn more than $250,000 per annum), rather than marginal tax rates which are usually higher than 15%. Using salary sacrifice can also reduce your tax liability.
It’s important to consider that you will not be able to access funds contributed to super until you meet a condition of release, usually retirement. Income earners of over $250,000 per annum have their super contributions taxed at 30%. If superannuation concessional or non-concessional caps are exceeded, there are penalties.
When planning for your financial future, it’s important to consider your individual circumstances and stage of life. We encourage you to seek professional advice to help you take advantage of appropriate financial planning strategies as your circumstances and priorities change.
If you would like to know more about making the most of your financial future, I encourage you to contact us on (07) 3720 1299 or email admin@wealthfundamentals.com.au
1 https://www.moneysmart.gov.au/tools-and-resources. Figures based on 4.5% interest rate and $10 monthly fees. For additional assumptions and disclaimers see the Money Smart website.
2 https://www.moneysmart.gov.au/tools-and-resources Based on a balance of $200,000, medium fee levels and a balanced investment option with an investment return of 4.8%. For additional assumptions and disclaimers see the Money Smart website.
3 https://www.moneysmart.gov.au/tools-and-resources. Figures based on 4.5% interest rate and $10 monthly fees. For additional assumptions and disclaimers see the Money Smart
website.
4 https://www.moneysmart.gov.au/tools-and-resources Based on a balance of $200,000, monthly pre-tax contributions of $850, medium fee levels and a balanced investment option with an investment return of 4.8%. For additional assumptions and disclaimers see the Money Smart website.
5 https://www.moneysmart.gov.au/tools-and-resources
Lane Moses Pty Ltd ABN 56 092 186 117 trading as Wealth Fundamentals and its advisers are Authorised Representatives of Fortnum Private Wealth Ltd ABN 54 139 889 535 AFSL 357306.
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