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.
- 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.
Your guide to gearing
By Robert Wright /August 21,2023/
There are a number of considerations when it comes to gearing, the investment assets you may choose to gear and the way you structure your debt.
A gearing strategy can be set at three levels:
- Positive gearing – where income from the investment exceeds the interest payable on the loan.
- Neutral gearing – where income from the investment is equal to the interest payable on the loan.
- Negative gearing – where the income from the investment is less than the interest payable on the loan. The excess interest expense is an allowable deduction against other assessable income, which for a taxpayer on the top marginal rate is currently worth 47% (inclusive of the Medicare levy).
Investing in growth assets such as shares or property using borrowed funds can be one of the most effective ways to accumulate wealth over the long term.
Investors are solely relying on a future capital gain when undertaking a negative or neutral gearing strategy. Negative gearing is tax effective in that the interest expense is fully deductible against the income generated by the geared investment and other assessable income. There are also other tax breaks such as the deductibility of depreciation (for property) and franking credits (for shares) to help subsidise the cost of the investment. In addition, for individuals, 50% of any capital gain is exempt from tax where the investment is held for at least 12 months.
Positive gearing strategy
If $100,000 were invested for a year in assets that produced a return on investment of 10% per annum, the total return on investment would be $10,000.
If the investor had also used a gearing strategy and borrowed $50,000 (at a cost of 7% per annum) and invested this in the same assets producing the same 10% per annum return, the return on investment would be 10%, less the cost of finance (7%) – that is, a net additional return of $1,500 using someone else’s money.
The net return can be greater than this when the tax deductibility of interest is taken into consideration.
The below examples of negative gearing illustrate how the negative cash flow from the investment can be offset by the deductibility of interest plus other tax breaks.
Negative gearing an investment property
Sarah earns a salary of $200,000 and borrows $400,000 to buy an investment property. The property generates rental income of $20,000 per annum while interest expense on the loan (interest only with no principal repayments) is 7% or $28,000 per annum. In addition to the deductible interest expense, there are the following ‘non-cash’ deductions:
- $2,500 depreciation
- $4,500 building amortisation (2.5% based on a construction cost of $180,000)
|Without negative gearing strategy
|With negative gearing strategy
|Non-cash property deductions
|Tax payable (incl. Medicare levy)
The difference in cash flow of only $950 has been assisted by the $7,000 tax deduction for the non-cash depreciation and building amortisation expenses.
These examples demonstrate the worth of tax deductions to an individual on the top marginal tax rate in the first year of a negative gearing strategy. Over time, negatively geared investments can become positively geared – especially when rental income or dividends are reinvested.
Couples with one person on a higher marginal tax rate than the other, should carefully consider who should be the borrower and owner of investments over the long term. While initially it may be tax effective to have a negatively geared investment in the name of the person with the highest tax rate, if it’s expected to become positively geared in the future, it may be more effective to have the loan and investment in the name of the person with the lower marginal tax rate from the outset. Especially when you consider the potential capital gains tax, stamp duty and loans fees that might be incurred in transferring the investment and loan.
Trusts and companies can also negatively gear investments, however the following should be considered:
- Trusts and companies cannot distribute losses, they need to be carried forward and offset against future assessable income.
- While the company tax rate is 30% for companies that are not base-rate entities which have a tax rate of 25%, companies are fully assessed on capital gains as opposed to the 50% discount applied to assets held for 12 months or more by individuals and trusts.
Negative gearing a share portfolio
Sarah earns a salary of $200,000 and borrows $400,000 to invest in a share portfolio. The share portfolio generates a dividend yield of 4% fully franked, while the interest expense on the loan (interest only loan) is 7% per annum under a line of credit secured against her home.
The below table illustrates the impact the negative gearing strategy has on Sarah’s cash flow.
|Without negative gearing strategy
|With negative gearing strategy
|Imputation gross up
|Tax payable (incl. Medicare levy)
|Tax payable (incl. Medicare levy) and after franking credit
The difference in cash flow is $2,726 which is approximately 0.7% of the investment portfolio. Sarah hopes that her after-tax capital gain will be greater than this cash flow loss.
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.
How ‘Buy Now Pay Later’ affects your credit score
By Robert Wright /November 23,2021/
In recent years, ‘buy now pay later’ (BNPL) has become an increasingly popular method for consumers looking to purchase goods via instalments without resorting to credit cards.
These services are often billed as a safer and more convenient way for consumers to manage their spending, and their popularity has led them to become widely available.
But if you miss a payment or misunderstand the particular terms you’re agreeing to, BNPL has the potential to dent your credit score and impact your lending ability down the track.
What is BNPL?
The BNPL market is growing exponentially. Valued at $43 billion, this sector has tripled over the previous two financial years, according to the Reserve Bank of Australia.
BNPL schemes allow consumers to buy goods and services from a retailer by only paying a fraction of the price at the time of the transaction and the rest of the payments in instalments. This convenient payment method offers interest-free payments to consumers and is currently attracting considerable attention. However, if you miss payments, you could be in trouble.
In the 2018-19 financial year, the total revenue from missed payments from all BNPL providers totalled over $43 million, a 38 per cent increase from the previous financial year.
Many people, especially younger consumers, have a general understanding of what a credit score is and that a bad credit score, or rating, can affect their ability to secure loans or lines of credit.
What they may not realise is that almost every transaction they make has the potential to impact their credit score – whether it is paying a utility bill late, carrying a lot of ‘contract debt’ by upgrading your phone every year on a plan, regularly overdrawing your bank account and using overdraft, or having multiple credit cards and only paying the minimum monthly fee.
All of these factors are taken into consideration to give a picture of your spending habits and determine whether you are a desirable candidate to lend money to. So, while it may not seem like a big deal if you pay your electricity bill a few days late, or you’ve signed up to a five year plan to pay off the latest iPhone, or regularly using BNPL services to pay for things, these actions may be chipping away at your credit rating which could cause issues when it comes to seeking a home loan down the track.
Improving your credit score
The first step is to go online and check your credit report. This is generally a free process, and everyone is entitled to one get a credit report once a year. Ensure all your personal details and queries on your credit history are correct. However, beware of any credit repair companies that claim to improve your credit score. This is simply ineffective and a rip-off.
Here are some steps to help you improve your credit score and make yourself a more desirable loan candidate if you expect to be applying for a home loan in the near future.
- Resist the lure of BNPL and other easy spending
To avoid additional scrutiny of your personal spending habits, it may be better to close your BNPL accounts and focus on only purchasing things you can pay for in full. Resist the urge to upgrade your phone unnecessarily so you can pay out your existing plan.
- Limit the amount of credit applications
In the year leading up to your mortgage application, be cautious of applying for credit. It is advised to wait until after your loan has settled to then apply for credit and take advantage of interest-free loans.
- Close any unused credit cards
If you have any unused credit cards, it is advisable to close them to increase your borrowing capacity. When assessing your loan application, a lender will often assume all credit limits are fully drawn and will count the minimum payment as an expense. This may be the difference between getting the loan or not.
- Demonstrate stability in employment and residency
Staying in the same workplace and household for at least six months is key to obtaining a home loan. Banks like to see stability, and moving jobs or houses can compromise getting a loan approved.
Source: Money & Life