Coal Coast Mag - How to stash your cash... Your money questions answered
Should you make it a priority to pay off my mortgage before everything?
The debate over the best place to stash your cash is one that is hotly contested, with most people claiming that the home mortgage is the be all and end all. Whilst there is some merit in this, it’s important to look at the big picture before switching on auto-pilot and directing all your hard earned savings onto your mortgage, without a second thought.
Generally when interest rates are high, your best bet is to reduce your mortgage as quickly as possible. You know how it works; the larger the balance and the longer you leave it, the more interest you repay the bank - but current market conditions have changed the game. Interest rates are at their lowest levels in decades freeing up cash flow which can be used for investment opportunities.
Take Josh and Jenna, they are both 40 years of age, employed and earn $90,000 and $75,000 respectively. Together they have a $600,000 home mortgage with an interest rate of 6.00% (conservative long term average rate). They have $750 and $500 per month in surplus cash flow (after minimum principal and interest repayments) and are funnelling this combined amount to make additional monthly repayments onto their mortgage.
Rather than directing their combined $1,250 per month to their mortgage, if they went with a different strategy and made salary-sacrifice contributions into Super via their employer, at age 65 Josh and Jenna would be $149,786 better off with an additional $708,193 contributed to Super which far outweighs the home loan saving of $563,406.
This scenario assumes a modest annual investment return of 7% pa and captures just how generous Superannuation tax breaks can be. Josh and Jenna will not pay income tax on the portion they salary sacrifice into Super but pay a super contributions tax of 15%.
This strategy becomes even more compelling if Josh and Jenna were to come into a higher income bracket and earn $150,000 each. In this case they would be approximately $210,494 better off collectively. However, this strategy becomes less beneficial the higher the interest rates rises. The break-even point in this scenario would be an interest rate of around the 8.5% pa mark which is a far cry from the 3 and 4-point-something mark we are seeing at the moment.
So why aren’t we all feverishly salary sacrificing every last cent into Super? Before you jump in there are a few things to consider to determine whether this strategy is the right one for you.
Firstly, there are contribution rules to minimise the pre-tax income directed to Super, which depends on your age and your income level.
Secondly, for most, the security of having a fully paid off home generally provides peace of mind, whilst freeing up income for any big monthly repayments, bills and other expenses. Accessibility is also a big factor - once you direct the benefits into your Super fund you usually cannot access it until age 65.
It all comes down to your individual situation and personal preferences. You must factor in your age when making a decision and give thought to how important it is to preserve your cash, whilst weighing up how disciplined you are. By putting your long-term goals and objectives down and considering what is most important to you, the decision can be made a lot simpler.
In answering readers' questions the advice is of a general nature and is not a substitute for personal financial advice from an independent adviser.