Q23: Mortgage or Super?

In our first reader question we provide a framework to find an answer to this conundrum.

Recently a TMQ reader asked about the difference between paying extra on a mortgage or extra to super.

We provide a framework to help you make your choice.

Life wasn’t meant to be easy

And, unfortunately, neither is the answer to this question, but we’re going to have a crack at it, because it’s a question that’s often asked and the answer to it allows us to cover a few financial issues that everyone should be aware of. One concept to get to know is called “opportunity cost”. It means that by taking one course of action you can’t take any others. It’s especially relevant when you spend money: you can only spend it on one thing at a time.

Setting the Scene

You recently read our post on saving money and you find yourself with $500 per month extra, pre-tax, which you can use to pay off your house or to put into super. Everyone’s situation is different so, to get to the bottom of this one, we’ll need to make a few assumptions. Here’s our list:

  • Salary is $100,000 a year
  • Employer is paying $9,500 into super for you
  • Super will earn 6.5% a year
  • Superannuation concessional contributions limit is $25,000
  • $100,000 owing on a mortgage, with 10 years to go
  • Mortgage interest rate is 4.00%
  • Marginal tax rate is 39%, all inclusive
  • Tax on salary sacrifice to super is 15%

The first thing to understand is that $500 in salary is worth

  • $305 in your pocket
  • $425 in your super

this is because our marginal tax rate is 39%, and any additional payments to super are taxed at 15%. So right away, additions to super allow us to keep more of our money. But let’s look at two options: pay the mortgage first or pay super first.

We’ll use a 10 year time horizon, which is the time it would take to pay off the mortgage if we changed nothing.

Option 1: Pay Mortgage First

It’s a great feeling when your mortgage is paid off

Let’s look at our mortgage payments. Using our scenario above we’re already paying $1,012 a month and, after ten years, we’ll own our home after having paid a total of $121,495.

By making an extra payment of $305 each month we will pay off our example mortgage in 7 years and 4 months, instead of 10 years. Additional payments total $26,736, and we avoid paying $6,009 in interest charges. That’s like “earning” $6,009 because it’s interest we don’t have to pay.

We’re now mortgage-free, nearly three years ahead of schedule. The way to make this really work is to get stuck into salting money away by continuing to invest our mortgage payment into our super fund. On a pre-tax basis we’ll have $25,917 per year available (our total mortgage payment before tax) to invest in super. The superannuation concessional payment cap is $25,000, of which our employer pays $9,500 so we could pay in an extra $15,500 (after paying tax of only 15%) each year to super. That leaves $7,681 pre-tax dollars, which is $4,685 in our pocket, extra each year to invest or just to spend on something enjoyable.

In summary after ten years we’ve been able to put an extra $26,735 into our mortgage and an extra $41,333 into super. We saved $6,009 in interest and earned an extra $3,665 on our additional super payments. Therefore:

  • Total Extra Capital: $41,333 (super)
  • Total Extra Earnings: $9,674 (interest earned and avoided)
  • Total Extra Pocket Money: $12,495
  • Total Extra for Us: $63,503

Option 2: Pay Superannuation First

Superannuation contributions incur a lower tax rate

Now let’s look at paying the extra to super instead of our mortgage.

Remember we said that $500 is taxed less if you salary sacrifice it to super? This lower tax rate acts like a magic wand: it adds about 39% to your money. So you put $425 per month into super. After ten years you’ve put an extra $51,000 into your superannuation and it’s grown to $71,571. Compound interest does the hard work for us and the lower tax rate gives us more money to invest.

  • Total Extra Paid In: $51,000
  • Total Earnings: $20,571
  • Total Extra for Us: $71,517


On the basis of our example, it’s clear that paying super first is the better option. This is because of the lower tax rate on superannuation contributions and the longer compounding period of those contributions. when we pay the mortgage first, even with the big extra super contributions in the last 2 years and 8 months turbo-charging our superannuation investment, there’s a much shorter time for the compounding effect to help our final balance.

Decision Time

While the numbers themselves may look clear-cut there are some personal preferences and circumstances that may affect the choice any person makes. If we contribute to super first, our money is locked away until retirement. Yes, we get a tax benefit but we lose the flexibility to redraw our extra payments if we have a need for short term cash. This could be important as insurance against the unforeseen.

For some, the security of paying off a mortgage and the warm feeling of knowing you own your own home is hard to put a value on. There’s a great deal of comfort to be had in being debt-free.

Everyone’s situation is different and the final decision rests with you and your financial adviser. The analysis presented above doesn’t consider any particular circumstances and a full account of your own situation is needed to reach a final decision. As noted when we began, the answer to the mortgage/super question is not necessarily black and white.

Only you can decide what is the best option for your circumstances. You might calculate the numbers for yourself and be convinced that super is your best option. Or you might like the security of knowing your house is paid and you have something to draw on in an emergency. Perhaps a bit of both works for you.

Whatever you choose, we hope our methodology provides a basis for your own calculations.

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