Pay down the home loan or top up super: Which is best?

Many borrowers look to pay down the mortgage before taking care of their retirement savings. But is that the right strategy?

Paying down the mortgage or adding to super -- Canstar has crunched the numbers on which one delivers the most benefits financially. Picture: iStock

Mortgage holders sighed with relief this week when the Reserve Bank kept the cash rate on hold. But the prospect of rates staying higher for longer no doubt has some borrowers eyeing their debt mountain with rising dread.

We know some are really struggling with the higher cost-of-living, to the extent their parents are having to step in to help pay the monthly mortgage. But for those with a bit of extra cash to hand – and keep in mind the start of the financial year is just over a week away, bringing with it both stage 3 tax cuts and, for many, the annual pay rise – the question is often whether to pay down the home loan or top up super.

Rates jump puts focus on home loans

For many of us, it was drilled in at an early age that debt needs to be taken care of first. Then there was a big shift when rates got to ultra lows a few years ago. Why get a 2 or 3 per cent benefit from paying down the home loan earlier when markets were doing multiples of that.

But with monthly repayments jumping 50 per cent or more since the cash rate started to march higher, those handy online mortgage repayment calculators now deliver a rude shock for anyone brave enough to look.

Borrowers appear to be moving back to the more traditional mindset when it comes to knocking down the home loan debt: there was a record $271bn sitting in offset accounts at the end of March, according to the prudential regulator.

Keep in mind, we don’t even know if we’re at the peak of the cycle yet: The RBA this week kept the door firmly open for the next move to potentially be up, saying it was “not ruling anything in or out”.

Then we’ve got to consider that first homeowners are getting older. If you take out a mortgage in your 40s, chances are you’ll still be paying in retirement if you stick with the original payment plan. Indeed, that’s what many of us expect to happen, according to new research from investment giant Vanguard.

All up, a third of Millennials and close to half of Gen Z who expect to one day own a home believe they’ll still be paying off a mortgage in retirement, research released by Vanguard this week showed.

This is a bit of a sleeper issue when it comes to retirement and why it’s so important to have a “robust” superannuation balance as of a ‘whole of wealth’ retirement plan, according to Vanguard Australia managing director Daniel Shrimski.

Pay down debt or top up super: comparing strategies

This brings us to a useful little exercise for weekend readers. Is the home loan really the best place to put your money to work? Or should you tip that cash into super and get compounding and tax benefits?

Figures compiled by research house Canstar for The Weekend Australian suggest there is a clear winner.

Take note, there are a number of assumptions made in this comparison exercise, including that rates remain at 6.22 per cent, average super returns stay at 7.6 per cent (the current seven-year average) and that the additional contribution cap sits at $30,000 (which it will be from July 1). The comparison is over a 10-year time period.

According to Canstar’s modelling, if you have a $500,000 home loan and tip an extra $1,000 into your monthly repayments, you’ll save $45,850 in interest over 10 years.

If you have an $800,000 mortgage and tip in an extra $2,000 a month, you’ll save $91,701 over 10 years.

And if you have a $1,000,000 home loan and tip in an extra $3,000 a month, you’ll save $137,552 over 10 years.

Super fares even better, according to Canstar.

A worker earning $120,000 who adds $1,000 a month to their super via the concessional path will get a potential benefit of $69,045 after 10 years, based on tax savings and estimated earnings, the modelling shows.

A wage earner on $195,000 who tips an additional $2,000 in a month, maxing out the concessional contributions and then putting the rest in via non-concessional top ups, will get a potential benefit of $134,978 after 10 years.

And those lucky enough to be earning $240,000 who add an extra $3,000 a month to their super, again maxing out the concessional contributions and then putting the rest in via non-concessional top ups, are looking at a potential benefit of $183,413 within 10 years.

Easy access versus locking up savings 

Super clearly comes out in front from a purely financial standpoint. But we know that’s not the only consideration for borrowers.

One key issue that would hold people back is not being able to access super until retirement, says Canstar group executive for financial services Steve Mickenbecker.

“Super is a one-way transfer whereas paying the loan down can be reversed by redraw. This means that the super avenue cuts back on future flexibility and in some cases that can be for half a lifetime,” he says.

For financial adviser Glen Hare, of Fox and Hare Wealth, the focus should be on the long-term goal and how to best get there.

“If you’re just defaulting to paying down the mortgage as fast as possible, then what happens when the mortgage is paid off? You’ve given no focus to super, you’ve given no focus to diversification and you’ve done nothing to reduce your tax liability,” he says.

“It’s not a bad strategy if you’re sitting there in a home and completely debt free. But you’ve missed out on some opportunities along the way.”