Mortgage vs Super
With interest rates on the rise and investment returns increasingly volatile, Australians with cash to spare may be wondering how to make the most of it. If you have a mortgage, should you make extra repayments or would you be better off in the long run boosting your super?
The answer is, it depends. Your personal circumstances, interest rates, tax and the investment outlook all need to be taken into consideration.
What to consider
Some of the things you need to weigh up before committing your hard-earned cash include:
Your age and years to retirement
The closer you are to retirement and the smaller your mortgage, the more sense it makes to prioritise super. Younger people with a big mortgage, dependent children, and decades until they can access their super have more incentive to pay down housing debt, perhaps building up investments outside super they can access if necessary.
Your mortgage interest rate
This will depend on whether you have a fixed or variable rate, but both are on the rise. As a guide, the average variable mortgage interest rate is currently around 4.5 per cent so any money directed to your mortgage earns an effective return of 4.5 per cent.
When interest rates were at historic lows, you could earn better returns from super and other investments; but with interest rates rising, the pendulum is swinging back towards repaying the mortgage. The earlier in the term of your loan you make extra repayments, the bigger the savings over the life of the loan. The question then is the amount you can save on your mortgage compared to your potential earnings if you invest in super.
Super fund returns
In the 10 years to 30 June 2022, super funds returned 8.1 per cent a year on average but fell 3.3 per cent in the final 12 months. In the short-term, financial markets can be volatile but the longer your investment horizon, the more time there is to ride out market fluctuations. As your money is locked away until you retire, the combination of time, compound interest and concessional tax rates make super an attractive investment for retirement savings.
Tax
Super is a concessionally taxed retirement savings vehicle, with tax on investment earnings of 15 per cent compared with tax at your marginal rate on investments outside super.
Contributions are taxed at 15 per cent going in, but this is likely to be less than your marginal tax rate if you salary sacrifice into super from your pre-tax income. You may even be able to claim a tax deduction for personal contributions you make up to your annual cap. Once you turn 60 and retire, income from super is generally tax free. By comparison, mortgage interest payments are not tax-deductible.
Personal sense of security
For many people there is an enormous sense of relief and security that comes with having a home fully paid for and being debt-free heading into retirement. As mortgage interest payments are not tax deductible for the family home (as opposed to investment properties), younger borrowers are often encouraged to pay off their mortgage as quickly as possible. But for those close to retirement, it may make sense to put extra savings into super and use their super to repay any outstanding mortgage debt after they retire.
These days, more people are entering retirement with mortgage debt. So whatever your age, your decision will also depend on the size of your outstanding home loan and your super balance. If your mortgage is a major burden, or you have other outstanding debts, then debt repayment is likely a priority.
All things considered
As you can see, working out how to get the most out of your savings is rarely simple and the calculations will be different for everyone. The best course of action will ultimately depend on your personal and financial goals.
Buying a home and saving for retirement are both long-term financial commitments that require regular review. If you would like to discuss your overall investment strategy, give us a call.
The big picture
Even though investors have come to expect unpredictable markets, nobody could have predicted what unfolded in 2022.
Russia’s invasion of Ukraine in February triggered a series of unfortunate events for the global economy and investment markets. It disrupted energy and food supplies, pushing up prices and inflation.
Inflation sits around 7 to 11 per cent in most advanced countries, with Australia and the US at the low end of that range and the Euro area at the higher end.
As a result, central banks began aggressively lifting interest rates to dampen demand and prevent a price and wages spiral.
Rising inflation and interest rates
The Reserve Bank of Australia (RBA) lifted rates eight times, taking the target cash rate from 0.1 per cent in May to 3.1 per cent in December. This quickly flowed through to mortgage interest rates, putting a dampener on consumer sentiment.
Australia remains in a better position than most, with unemployment below 3.5 per cent and wages growth of 3.1 per cent running well behind inflation.v
Despite the geopolitical challenges, Australia’s economic growth increased to 5.9% in the September quarter before contracting to an estimated 3 per cent by year’s end, in line with most of our trading partners.
Volatile share markets
Share investors endured a nail-biting year, as markets wrestled with rising interest rates, inflation, and the war in Ukraine.
Global shares plunged in October on interest rate and recession anxiety only to snap back late in the year on hopes that interest rates may be near their peak. The US market led the way down, finishing 19 per cent lower, due to its exposure to high-tech stocks and the Federal Reserve’s aggressive interest rate hikes. Chinese shares (down 15 per cent) also had a tough time as strict Covid lockdowns shut down much of its economy.
Australian shares performed well by comparison, down just 7 per cent, thanks to strong commodity prices and the Reserve Bank’s relatively moderate interest rate hikes.
Energy and utilities stocks were strong due to the impact of the war in Ukraine on oil and gas prices. On the flip side, the worst performers were information technology, real estate and consumer discretionary stocks as consumers reacted to cost-of-living pressures.
Property slowdown
After peaking in May, national home values fell sharply as the Reserve Bank began ratcheting up interest rates. The CoreLogic home value index fell 5.3% in 2022, the first calendar year decline since the global financial crisis of 2008.
As always though, price movements were not uniform. Sydney (-12 per cent), Melbourne (-8 per cent) and prestige capital city properties generally led the downturn. Bucking the trend, prices continued to edge higher in Adelaide (up 10 per cent), Perth (3.6 per cent), Darwin (4.3 per cent) and many regional areas.
Rental returns outpaced home prices, as high interest rates, demographic shifts and low vacancy rates pushed rents up 10.2 per cent in 2022. Gross yields recovered to pre-Covid levels, rising to 3.78 per cent in December on a combination of strong rental growth and falling housing values. However, it’s likely net yields fell as mortgage repayments increased.
Despite the downturn, CoreLogic reports housing values generally remain above pre-COVID levels. At the end of December, capital cities combined were still 11.7 per cent above their March 2020 levels, while regional markets were a massive 32.2 per cent higher.
Looking ahead
While the outlook for 2023 remains challenging, there are signs that inflation may have peaked and that central banks are nearing the end of their rate hikes.
Even so, the risk of recession is still high although less so in Australia where the RBA has been less aggressive in applying the interest rate brakes.
Issues for investors to watch out for in the year ahead are:
A protracted conflict in Ukraine
A new COVID wave in China which could further disrupt supply chains across the Australian economy, and
Steeper than expected falls in Australian housing prices which could lead to forced sales and dampen consumer spending.
If you would like to discuss your investment strategy in the light of prevailing economic conditions, don’t hesitate to get in touch.
Disclaimer
The information provided is general advice only has not taken into account your financial circumstances, needs or objectives. This publication should be viewed as an additional resource, not as your sole source of information. Where you are considering the acquisition, or possible acquisition, of a particular financial product, you should obtain a Product Disclosure for the relevant product before you make any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. It is imperative that you seek advice from a registered professional financial adviser before making any investment decisions.
Whilst all care has been taken in the preparation of this material, no warranty is given in respect of the information provided and accordingly neither Centrepoint Alliance Ltd nor its related entities, guarantee the data or content contained herein to be accurate, complete or timely nor will they have any liability for its use or distribution.