Super options for your home loan
Paying off your mortgage as quickly as possible has long been the mantra of financial planning – clear your non-deductible debt first. However, with the Federal Budget changes announced in May 2006, the potential to access money tax-free from your super once you turn 60 has shifted opinion.
There is now a growing – although not overwhelming – argument to divert some of your mortgage repayments to your super rather than paying off your loan quickly.
The strategy
The strategy revolves around converting your current principal-and-interest mortgage into an interest-only home loan. This will effectively reduce your monthly loan repayments.
You then need to be disciplined enough to salary sacrifice the money you save on your loan repayments into super.
Salary sacrificed contributions will only attract a 15% contributions tax; mortgage repayments are made using your after tax income on which you may have already paid up to 46.5% tax. By salary sacrificing, you are able to contribute a larger net amount than what you are actually saving in loan repayments and still end up with the same amount of net income.
Once you reach 60, you can then draw down the money from your super tax-free and pay the outstanding mortgage in full. In most cases, you will end up with a surplus amount in super.
Case study 1 – How does this strategy work?
Take Jack aged 50, who has a $200,000 home loan. He’s on a 41.5% marginal tax rate, paying 7% interest on his mortgage. If he were to continue with the principal-and-interest mortgage through to the end of the existing term in 10 years’ time, he would be required to make an annual post-tax payment of $26,613 a year. This is equivalent to $45,492 in pre-tax dollars.
Switching to an interest-only mortgage will result in his loan repayments dropping to $13,084 a year. This is equal to $22,366 a year in pre-tax dollars. He can now afford to salary sacrifice $23,126 a year into super ($22,366 plus $23,126 equals $45,492 which is the pre-tax amount he was previously paying into his principal-and-interest mortgage).
After 10 years with the principal-and-interest mortgage, Jack would have paid out his loan but would not have created any additional super.
After converting his loan to interest-only, his annual salary sacrifice contributions of $23,126 a year would result in $290,603 invested in super over the same 10-year period, assuming a 7% return. After paying out the $200,000 on his mortgage, this would leave him with an additional $90,603 in super.[1]
The higher your tax rate, the greater the benefit. If he was on a 46.5% marginal tax rate, he would end up with $117,796 in super and even with a tax rate of just 16.5% he’d still be $3,570 ahead.
Extend your loan
Unfortunately, not all mortgages can be switched to interest-only. If this is the case, then you might consider extending the term of the loan as a means of reducing your monthly loan repayments. This will achieve a similar outcome.
Case study 2 – How does extending your loan work?
If Jack had extended the term of his existing mortgage rather than switching to an interest-only loan, he would still have freed up extra cash with which to make salary sacrifice contributions into super.
Extending Jack’s loan term by 5 years would result in $40,789 extra super at the end of year 10. A 10-year extension of his loan would reap an additional $60,068 and a 20-year extension, $77,345.
What will make these strategies work?
The return on the super investment needs to at least match the interest payments on the mortgage in order for the strategy to work.
In Jack’s case, and based on a 7% earning rate, if interest rates were to rise to 13.55%, then he would only break even. A rise in interest rates above that amount would negate this strategy’s effectiveness.
So the lower the interest rate and the higher the return on the super, the better the benefit.
Contact your financial planner to find out how you can benefit from these home loan strategies.
1. Money contributed and accumulated within your superannuation fund will be subject to preservation rules and you will generally not be able to access these funds until a condition of release is met, eg retirement.