Retirement goals are also important.
“Sometimes people might want to downsize in retirement, therefore they don’t mind having a residual loan balance knowing with confidence that the loan will be paid off with the downsizing,” says Fang. “In this scenario, they would tend to concentrate on building up their retirement nest egg.”
Another important factor is the person’s marginal income tax rate, because while home loan repayments are usually made with after-tax money, super contributions can be made with either pre-tax or post-tax dollars, Fang explains
She gives the example of a person on the marginal tax rate of 34.5 per cent (this is the $37,000 to $90,000 tax bracket which is considered to be the average Australian income) who has a surplus cashflow of $1,000 pre-tax.
To contribute to super before tax, only 15 per cent tax is deducted, which means $850 goes into super. Subsequently, the person’s overall taxable income is reduced, meaning they pay less income tax.
When looking at home loans, after deducting marginal tax rate of 34.5 per cent, only $655 goes towards paying off the mortgage.
Australians are allowed to make up to $25,000 a year in pre-tax superannuation contributions and Fang says people in a high tax bracket with large amounts of surplus cash might consider making the maximum contribution and then putting any additional cash towards their home loan.
Andrew Bartolo, head of home loans at ME Bank, outlines the savings which can come from making extra mortgage payments.
If someone paid an extra $250 a month from the start of a 25-year home loan of $400,000, they would save around $43,000 and take more than four years off the home loan. An extra $500 a month would save about $73,000 and take seven years off.
“Following this strategy can save money and free you from repayments much sooner, allowing you to put that cash to something else, like superannuation or another investment,” he says.
Another important consideration is whether the mortgage is over a home or an investment property, says Bartolo. Interest payments on investment loans are tax deductible but payments on loans for a person’s own home are not, so that should be a priority to pay off ahead of investment loans.
It also depends on a person’s risk appetite, the retirement plans and what sort of returns they think they might from superannuation compared with the savings they would make by paying off the mortgage more quickly, says Bartolo.
Fang agrees, saying: “At the moment interest rates are at a record low, so extra money into your super could potentially earn you more in returns than what you are paying in loan interest.”
However, she says that even when the calculations suggest it would be a good idea to put extra funds towards superannuation, there is one more important consideration – what she calls the “sleep well test”.
“Can you sleep well at night with your decision? I have some clients who just wanted to pay off the home loan as the be all and end all goal as they cannot justify paying so much interest to the bank,” she says.
It is also important to weigh up the “knowns” and the “unknowns”.
Fang says what is known the interest rate on a person’s home loan and so they can be confident that the sooner they pay off the home loan the less interest they will end up paying.
What is unknown are investment returns, market conditions, legislative changes such as super rule changes and tax on super.
She sums up: “At the end of the day there is no right or wrong decision here, as everyone’s circumstances are different, although the ideal situation would be to do a bit of both. Also as circumstances change in life people can always review their situation and make changes to their initial set up. That’s why we always recommend you seek advice for specific to you.”
AustralianSuper manages more than $142 billion of members’ retirement savings on behalf of more than 2.3 million members from around 285,000 businesses. One in 10 working Australians is a member of AustralianSuper, the nation’s largest superannuation fund.
To learn more about what’s needed for the retirement lifestyle you want, head to Home in the Next Third.