Tag Archives: Budgetting

Mortgage vs super: where should I put my extra money?

By Robert Wright /February 16,2024/

It’s a dilemma many of us face – are we better off directing extra money to our mortgage or super? As with most financial decisions, it’s not a one size fits all approach and here are some factors to consider in deciding what’s right for you.

Key takeaways:

• There may be tax advantages when you contribute to super, especially if you salary sacrifice or you’re eligible to claim a tax deduction for personal super contributions.
• The power of compounding returns could mean that even small contributions to your super over many years could make the world of difference.
• By making extra mortgage repayments, coupled with any potential increase in the value of your property, you will build equity in your property at a faster rate than if you were to make just the minimum repayments.

Building the case for super over mortgage

You might think your super is already being taken care of – after all, that’s what your employer’s compulsory Superannuation Guarantee contributions are all about. But these contributions alone often aren’t enough to ensure you achieve the retirement lifestyle you want to live.

Making extra contributions to your super is a great way to boost your retirement savings. As an investment vehicle, super is a very tax effective way to save for the future.

The power of compounding returns

Super is a long term investment, at least until you retire, and potentially much longer if you leave your money in super and draw a pension after you retire.

This long investment term, coupled with the rate of tax on your super investment (generally 15%), means your money can add up and generate further investment returns on those returns. This is known as compound returns, or compounding.

The expenses of daily life can be considerable. Thinking about directing money to super might not seem like a priority when we feel overwhelmed by the effort to save a deposit for a home, paying down debt, and the costs of raising a family.

However, the benefit of compounding returns means that even small, frequent contributions can make a big difference down the track. It’s about striking a balance that is right for you today and remember, nothing has to be forever. As your life changes, you can simply adjust your contributions strategy to suit your needs.

Building super early

To maximise your retirement savings while allowing compounding returns to do the heavy lifting, the best approach is to start early. The longer compounding continues, the bigger your savings could be. Entering retirement debt free is an attractive prospect. It can be easy to think that you need to repay your debt before you can start thinking about saving for retirement. However, it doesn’t have to be one or the other.

You can see the difference small, regular contributions could make to your final retirement income using the MoneySmart retirement planner calculator.

Tax benefits of super

From a tax point of view, super can be incredibly beneficial. Salary sacrificing some of your before-tax salary or making a voluntary after-tax contribution for which you can claim a tax deduction, can be effective ways to not only grow your retirement savings but also reduce your taxable income.

One great benefit of investing in super is that concessional (before tax) contributions are taxed at a maximum rate of 15%. This can be higher though if you earn over $250,000.

Mortgage repayments are usually made from your take home pay after you’ve paid tax at your marginal tax rate. Your marginal tax rate could be as high as 47%. So, depending on your circumstances, making a voluntary deductible contribution to super or salary sacrificing may result in an overall tax saving of up to 32%.

There is a limit on the amount you can contribute into super every year. These are referred to as contribution caps. Currently, the annual concessional contributions cap is $27,500. If you’re eligible to use the catch-up concessional contributions rules, you may be able to carry forward any unused concessional contributions for up to 5 years. If you exceed these caps, you may be liable to pay more tax.

Tax on super investment earnings

The initial tax savings are only part of the story. The tax on earnings within the super environment are also low.

The earnings generated by your super investments are taxed at a maximum rate of 15%, and eligible capital gains may be taxed as low as 10%. Once you retire and commence an income stream with your super savings, the investment earnings are exempt from tax, including capital gains.

Also, when it comes time to access your super in retirement, if you’re aged 60 or over, amounts that you access as a lump sum are generally tax free.

However, it’s important to remember that once contributions are made to your super, they become ‘preserved’. Generally, this means you can’t access these funds as a lump sum until you retire and reach your preservation age, between 55 and 60 depending on when you were born.

Before you start adding extra into your super, it’s a good idea to think about your broader financial goals and how much you can afford to put away because with limited exceptions, you generally won’t be able to access the money in super until you retire.

In contrast, many mortgages can be set up to allow you to redraw the extra payments you’ve made or access the amounts from an offset account.

Building the case for reducing your mortgage over super

For many people, paying off debt is the priority. Paying extra off your home loan now will reduce your monthly interest and help you pay off your loan sooner. If your home loan has a redraw or offset facility, you can still access the money if things get tight later.

Depending on your home loan’s size and term, interest paid over the term of the loan can be considerable – for example, interest on a $500,000 loan over a 25-year term, at a rate of 6% works out to be over $460,000. Paying off your mortgage early also frees up that future money for other uses.

Before you start making additional payments to your mortgage, it’s suggested that you should first consider what other non-deductible debt you may have, such as credit cards and personal loans. Generally, these products have higher interest rates attached to them so there is greater benefit in reducing this debt rather than your low interest rate mortgage.

Conclusion: mortgage or super

It’s one of those debates that rarely seems to have a clear-cut winner – should I pay off the mortgage or contribute extra to my super?

The answer, probably somewhat annoyingly, is that it depends on your personal circumstances.

There is no one size fits all solution when it comes to the best way to prepare for retirement. On the one hand, contributing more to your super may increase your final retirement income. On the other, making extra mortgage repayments can help you clear your debt sooner, increase your equity position and put you on the path to financial freedom.

When weighing up the pros and cons of each option, there are a few key points to keep in mind.

One of the key questions to consider is what is the likely balance you’ll need in your super? Work backwards starting with working through what retirement looks like for you, the type of lifestyle you’d like, and how much you need to live on each year.

From there, you can start to consider your sources of income in retirement. This is likely to include super but could also include a full or part Age Pension, or income from an investment property or other sources.

You can then start thinking about your current balance, contributions strategies and whether you’re on track to have enough saved to supplement your other retirement income sources.

The MoneySmart retirement planner calculator can help you to estimate how much super you may have in retirement and how long your super may last. You also need to think about how you plan to spend your money in retirement.

In most cases, there isn’t one set strategy that you should follow and it can quickly change as you grow older, start a family and reach retirement age. You should also consider whether you’ll need to access any additional funds you put aside before you reach retirement. If it’s in your super, it’s locked away. If it’s in your mortgage, there are generally options to redraw.

Home ownership and comfortable retirement are financial goals that many strive towards. If you reach a point where there’s some surplus cash flow to consider where to put your extra money, it’s a good dilemma to have.

Life is complex, so it pays to speak with a financial adviser before you make any big financial decisions when it comes to your super or mortgage.

 

Source: MLC

Some recent questions on Australian inflation

By Robert Wright /August 21,2023/

Key points

• The Australian inflation rate peaked in the December quarter but has been slower to decline than some global peers. While interest rate rises are helping to reduce inflation (especially as discretionary consumer spending slows), rises in domestic energy prices, a tight rental market and a lagged pick up in wages have contributed to higher than expected inflation outcomes.
• The main policy available in the RBA’s toolkit to manage inflation is interest rates, which is a blunt tool because of its unequal impact on households with debt.
• The burden of interest rate increases falls on households with mortgage debt. Businesses and investors are also impacted but the deductibility of interest provides some offset.
• Some countries in Europe have opted to use price controls for essential items to reduce inflation, with mixed results. Price controls tend to add distortions to the market and rent controls are not helpful while housing supply is limited (like in Australia).
• But the government still has a role to play in helping the RBA achieve its 2-3% inflation target through keeping fiscal policy neutral/contractionary if inflation is high, ensuring a well functioning energy market, maintaining sustainable wage increases, regulating businesses to discourage price gouging and monopolistic behaviour and calibrating appropriate migration targets to match housing supply.

Introduction

Australian inflation is very high. Consumer prices were up by 7% over the year to March, around a 33-year high but this was a decline from a cyclical peak of 7.8% in December 2022. The Reserve Bank of Australia (RBA) has been focusing on reducing inflation through the main policy tool available in the central bank’s toolkit – interest rates. The cash rate has risen from 0.1% in April 2022 to 4.1% in June – a 4% lift in just over a year. But, the impact on inflation so far has been lower than expected. As a result, we are often asked whether interest rates are actually having an impact on inflation or whether there are better tools available to policymakers, especially as interest rate hikes are having an unequal impact across household groups. We go through some of these issues in this article.

Are interest rate hikes working to reduce inflation?

Interest rate hikes have led to a slowing in consumer demand which is helping to reduce inflation. Discretionary spending fell in the March quarter and the volumes of retail spending was negative over the December-March quarter. Without the lift in interest rates, inflation may have increased further and consumer and market-based medium-long term inflation expectations could have kept rising well above the RBA’s 2-3% inflation target.

Some might say that rate hikes should have worked faster or better by now to reduce inflation. The problem has been that there have been numerous supply driven elements of the inflation story that have been less sensitive to interest rate changes. COVID driven supply chain disruptions led to big increases in shipping costs, commodity prices like energy, metals and agriculture increased significantly in 2021-22 (mostly from supply disruptions), domestic energy supply issues led to an Australian energy crisis and multiple domestic floods led to higher food prices. While these issues may not be directly influenced by the level of change in interest rates, it is the responsibility of the RBA to ensure that supply driven price changes do not leak into consumer prices. A lot of these supply related issues are now resolved but it takes time for it to be reflected in the final inflation figures.

Evidence of excessive price gouging by businesses is not obvious. Profit margins have expanded (increasing from 10% in 2020 to a recent high of ~16%) but have generally moved in proportion to the rise in inflation (see the chart below) and are now declining. The profit share (ex mining) of GDP has also been fairly stable. And slowing consumer discretionary spending means that continued profit margin expansion will be unlikely.

Source: Bloomberg, AMP

The peak of Australian inflation (in December 2022) also occurred later compared to some global peers which means that the slowing in inflation appears like it’s taking longer. US inflation peaked at 9.1% in June 2022 and in the Eurozone at 10.6% in October 2022 (see the next chart).

Source: Macrobond, AMP

Australia’s energy crisis occurred later relative to the Northern hemisphere, because of a raft of our own domestic issues like supply challenges with coal, a poor national plan for the energy transition and higher global prices. This meant that both the US and Europe were more impacted by an energy price surge in early 2022 from the war in Ukraine and the winter weather. Australia’s rental market also tightened significantly over the past year as net migration rebounded to record highs after the pandemic, pushing vacancy rates to ultra low levels in the capital cities and lifted rents, although recent vacancy rates across the capital cities have ticked up and newly advertised rental growth is slowing. Australia’s wage setting system also seems to have more “inertia”, with the minimum wage decision occurring once a year and many other wages like awards also based off this annual decision or driven by changes to headline inflation, which only peaked in December 2022.

While these factors all suggest that inflation in Australia could remain higher for longer for now, the good news is that our Pipeline Inflation Indicator still suggests significant downside to Australian inflation over the next six months and we expect headline consumer prices to be at the top end of the RBA’s target band by early 2024 (on a 6-month annualised basis).

Source: Bloomberg, AMP

Are interest rate hikes increasing inequality?

The impact of monetary policy works primarily through the lending channel because borrowing rates are priced off the cash rate. Households with a mortgage are the most impacted by interest rate changes. Businesses and individual investors are arguably less impacted because they can deduct the debt interest expenses. There are also other financial market channels that monetary policy works through, mostly through the exchange rate.

The high level of household debt now means that mortgage holders will bear the brunt of monetary policy changes. Renters can also be affected from higher interest rates if landlords are able to pass on the higher cost of debt servicing through higher rents. This is only usually an option in a tight rental market (which the current situation is allowing for).

In Australia, 37% of households have a mortgage (using data from 2019-20), 29% rent and 30% own their own outright. Detailed ABS data on housing costs shows that households with a mortgage spend close to 16% of their gross household income on “housing costs” (mortgage or rent and rate payments) as at 2019-20, owners without a mortgage spend 3% of their income on housing costs and the average renter spends close to 20% of their income on housing. And there are divergences across income quintiles (see the chart below) with the lowest income quintiles spending a very large share of income on housing costs.

Source: Bloomberg, AMP

Are there other options to combat high inflation?

The high degree of supply related factors that have increased inflation, the slow reduction in prices despite aggressive interest rate hikes and the high burden placed on households with a mortgage has led to questions about whether there are other options available to reduce the level of inflation.

The RBA has been tasked with the responsibility for the 2-3% inflation target but the only tool at its disposal is monetary policy. While the range of options within the toolkit has expanded beyond interest rates (including yield targets and quantitative easing) all of these measures ultimately influence the money supply and therefore the cost of borrowing.

The government has more tools at its disposal compared to the RBA through its spending and taxation decisions as well as regulation. However, these tools are slow moving and do not have as much of a direct impact on inflation. Some have argued that price controls need to be considered in Australia. Food price caps have recently been tried in Europe for some essential items, including in France, Croatia and Hungary with mixed impacts as measured inflation went down but there were reports of some food shortages.

Usually, economists do not advocate for price controls or caps because it’s a distortion in the market and leads to problems like supply shortages. However, the Federal government did impose energy price caps domestically, so it is already being utilised in some capacity. Talk of rent controls would likely add to supply constraints across Australia at a time when housing supply needs to lift.

But, the government does have a role to play in many components that impact inflation, such as by ensuring a well regulated electricity market, sustainable outcomes for minimum award and public sector wages which set the tone for the rest of the market, ensuring that fiscal policy (both state and federal) is appropriate for the state of the economy (we think the impact of the May Federal budget is more or less neutral but with the addition of some state cost of living benefits it could be marginally inflationary and the government could consider raising taxes to help get inflation down), regulation of retailers to ensure adequate competition and ensuring adequate housing for the migration targets.

Implications for investors

For investors, the good news is that inflation is expected to decline through the rest of the year which should mean that central banks are close to the top of their tightening cycles. This is generally positive for sharemarkets however, the further interest rates increase, the higher the risk of recession which is a risk for sharemarkets. The RBA’s recent hawkish stance means that further increases to the cash rate are likely in Australia. We expect another two interest rate increases from here, taking the cash rate to 4.6% which risks a recession in the next 12 months because of the heightened sensitivity of households to interest rate hikes in Australia.

Source: AMP

What to do when your fixed rate home loan term is ending

By Robert Wright /May 19,2023/

Many Australians were fortunate to lock in record low interest rates but this may be drawing to an end.

A large portion of mortgages will be approaching the end of their fixed term, leaving many households paying two to three times their current fixed rate.

In this article, we’ll explain what to expect when your fixed interest rate ends and how to prepare for it.

What happens when your fixed rate home loan ends?

When your fixed term is nearing its end, you’ll need to decide whether to re-fix your loan at a new rate, change to a variable rate or consider switching to a new mortgage provider.

If you don’t do anything before the fixed term lapses, on expiry your mortgage provider generally switches your loan to its standard variable rate, which can be much higher than some of the discounted options available to new customers.

The best thing to do is contact your provider and ask them about your options, including what rates they can offer you.

How to prepare

Consider reviewing your mortgage at least 3 months before the fixed rate expires, as this will give you time to implement changes if required.

Here are some steps to go about this:

1. Negotiate with your current mortgage provider

It’s worth speaking to your current provider in advance to find out what variable rate you’ll be paying. This gives you an opportunity to check out other rates available in the market and think about whether switching providers is a better solution.

You can also see if you can negotiate a better rate as this may save you a lot of effort in moving to a new provider.

2. Research what other mortgage providers are offering

Now is a good time to see how your loan stacks up against other loans out there. This will help you determine if you’re getting a competitive interest rate.

If you do find a better offer, switching providers can be a smart move but it’s important to look at the costs involved in switching, borrowing costs and switching fees, as these can often outweigh the benefits.

Before you make any decisions, crunch the numbers with an online mortgage switching calculator.

3. Consider re-fixing your loan

If you like the predictability that comes with a fixed rate loan, you can re-fix your mortgage with an up to date interest rate.

However, you will be locked into the new fixed interest rate for a period of your loan term, unless you choose to end the contract earlier which may result in break costs.

Be sure to also carefully check out the features of a fixed loan too, such as fee-free extra repayments, redraw and linked offset accounts. Many fixed rate loans do not provide these features.

4. Consider a split loan

If you’re struggling to decide between a variable or fixed rate, or if you’re keen on a combination of flexibility plus certainty, you can choose to have part of your mortgage fixed and part of it variable.

For example, you could have 60% of your loan on a fixed rate and 40% on a variable rate.

This approach can provide the best of both worlds. The variable rate component gives you flexibility, while the fixed portion shelters part of your loan from rising interest rates.

5. Get help from an expert

If you can’t decide which option is best for you, a mortgage expert may be able to steer you in the right direction.

Mortgage experts can look at your finances and recommend some of the best home loan options to suit your specific needs. They’ll also be able to guide you through switching to another provider if that’s the path you choose to take.

Get a home loan health check

A home loan health check could help you to:

• find ways to fine tune your loan
• get more certainty or flexibility on interest rate options
• reduce your repayments
• pay off your loan sooner.

6. Make extra repayments before your fixed rate ends

If it’s possible for you to do so, consider paying off as much of your mortgage as possible before you’re hit with a higher interest rate.

By reducing your mortgage balance before your interest rate increases, you could save a lot of money on interest payments before it moves to the new rate.

How to manage higher repayments

When your fixed mortgage rate finishes and your repayments start increasing, your finances may need to be reviewed to cope with the new reality of rising interest rates.

There are ways to help you save and potentially earn more money, which may compensate for the rate increase.

1. Review your budget

While it may not be an option for everyone, there are expenses you can cut back on such as:

• taking public transport to work to reduce petrol costs and parking
• online shopping habits
• expensive memberships that you don’t regularly use
• taking advantage of government and council rebates to reduce your energy bill
• switching to energy efficient appliances and lightbulbs
• reviewing your utility and insurance providers – there may be better deals on offer which could save you hundreds of dollars.

 2. Increase your income

Looking for ways to increase your income can help you manage higher repayments once your fixed rate expires.

Consider asking your manager for a salary raise or look for a higher paying job.

You could also consider starting a side hustle like dog walking or online tutoring to make extra cash. Another option is to rent out a room or parking space.

3. Consider opening an offset account

An offset account is like a transactional savings account linked to your mortgage balance. The funds in this account can reduce the amount of interest you pay on your mortgage, so holding your savings here can be beneficial.

For example, if you have a $600,000 mortgage balance and $100,000 in your offset account, you’ll only be charged interest on $500,000.

Source: IOOF

Tips for Managing Money in Retirement

By Robert Wright /September 08,2022/

Aussies are living longer than ever before, with men expected to live until age 80 and women until age 85.

However, an increased life expectancy also means Australians may spend longer in retirement than previous generations, and in turn, need more money to fund retirement during those extra years.

When you’re retired and no longer earning money, it can be difficult to know how much you can afford to spend and what you need to preserve for the future, without the fallback of a regular retirement income.

You may also have added pressures in the mix, such as paying off debt, healthcare costs, and dependants in the form of kids or elderly parents.

Striking the right balance between enjoying your retirement and having enough to live on can be tough. However, you don’t have to go without – you may just need to consider your budget a bit differently.

If you’re planning your retirement , here are some money management tips that may help you get off on the right foot.

Look into having a U-shaped budget

Rather than a linear budget, where your expenses remain the same year after year, it may be worth considering a ‘U-shaped’ budget in your retirement. This is where your spending over the period of your retirement resembles a ‘U’, with the highest expenses in the first years of retirement and your later retirement years.

When you first retire, your spending will most likely be higher as you take that trip of a lifetime, splash out on that caravan or boat, or pay off your home loan (or all of the above) and engage in an active, and possibly more expensive, social life.

Your spending is then likely to settle into a more regular pattern in mid-retirement, before increasing again in your later years when greater healthcare costs and aged care expenses come into the mix.

Tips for paying off debt in retirement

Carrying debt into retirement isn’t ideal, but it’s a reality for many of us. If you find yourself owing money on your credit card, a personal loan or home loan once retired, there are things you could look into to help manage your repayments and minimise the amount of interest you pay.

Consolidating your debts by bringing them together into one loan could mean you pay less in interest, fees and charges. You could also contact your providers to try to renegotiate your repayment terms.

How much super should I have, and can I use this to pay off debt?

Some Australians withdraw their superannuation as a lump sum once they reach their super preservation age and use it to clear their debts, to avoid having any repayments and interest during retirement.

If you’re considering this, think about whether you’ll still have enough to live on in retirement, and the tax implications of doing this. In this case, it’s a good idea to speak with a financial adviser to weigh up your options.

Consider where you can save money

Although you may not have a steady income like before, it’s still possible to save money so you have more to spend on what’s important to you during your retirement. You can do this by leveraging some of the government’s benefits and subsidies, or by reducing your expenses.

Here are a few ideas to get started:

Consider selling your second car (if you have one), and take advantage of public transport concessions available to seniors instead. You may be able to save on car registration, insurance and maintenance costs, plus you’ll be doing a bit for the environment.

Take a look at government websites to learn about benefits and payments you may be able to access, such as pensions, allowances, bonuses, concession cards, supplements and other services.

Consider bundling your phone and broadband to save on technology bills, and your electricity and gas to save on energy costs. Compare providers’ rates through comparison websites and ask if they offer a seniors discount.

Think about ideas to entertain more at home instead of going out, such as dinner parties, game nights or movie nights. It also may be handy to subscribe for newsletters to your favourite restaurants and shops, or invest in a coupon book like the Entertainment Book, so you can take advantage of any offers and special deals when you do go out.

It may be worth putting your bills onto direct debit rather than paying them month by month. This way, you may be eligible to qualify for the pay on time discounts and avoid late fees if you forget a payment.

Groceries are a necessary expense, but it’s possible to save money here as well. Consider researching online for sales ahead of time, buying seasonally for fruits and veg, or buying in bulk and sharing with family or friends.

Tips if you’re helping your family financially

If you’re part of the ‘sandwich generation’, with elderly parents who are dependent on you and adult kids who are still at home or continue to need a bit of financial assistance, it’s still possible to have a good quality of life in retirement.

In order to do so, it’s all about finding balance. It’s important not to lose sight of your own goals during retirement, while still helping the ones you love. You may consider having some conversations with your children on the limits of what you can provide, and spend more time to help them understand the benefits of financial independence: for example, instead of financial assistance, perhaps you can help them with some invaluable financial education.

Tips if you’re estate planning

Estate planning is also an important part of your financial planning in retirement. Estate planning goes beyond just making a will. It can also be valuable to think about who your super beneficiaries are, and how you want to be looked after (both medically and financially) if you can’t make your own decisions later in life.

If you get your estate in order during the early years of retirement, it means more peace of mind in the long term and could potentially help prevent some family tensions in the future.

When planning your estate, here are some key things to think about.

Who will get your assets?

Making a will plays a big part in estate planning. A solicitor or estate lawyer can help you draw up a legally binding document that advises who should receive your assets after you pass away. If you don’t have a valid will, your estate will be distributed in line with the law in your relevant state.

Who is your executor?

An executor is the person responsible for making sure your assets are distributed according to your wishes, as well as paying bills, closing any banks accounts, and so on.

Who are the beneficiaries for your super?

Your super is often treated differently to the other assets in your will, so it can be useful to think about this as a separate aspect. Consider how you want your super to be distributed after you’re gone and try to keep your super beneficiary nomination up to date. If you don’t, there’s a risk that your super money may end up in different hands.

Who is your enduring power of attorney and/or guardian?

If you have an enduring power of attorney, you are allowing someone to make financial decisions on your behalf. In some states, your power of attorney holder can also make lifestyle decisions, such as health and medical choices and where you live, while in others you’ll need to appoint a separate guardian to do this.

Source: AMP