Should you use extra cash to reduce your mortgage or top up your KiwiSaver?

Which is better — boosting your savings or paying down the mortgage faster than you have to?

It depends. If we look at just the numbers, the comparison goes like this:

  • How much interest are you paying on your mortgage?
  • How much can you earn on your savings — after fees and taxes?

Go with whichever is higher. Avoiding paying interest is as good as earning interest.

There are a few complications, though.

If your savings are in bank term deposits, you’ll know the interest rate. It will usually be lower than your mortgage interest rate, so it’s best to put your extra savings into mortgage reduction.

But what if you don’t know what your return will be?

For longer-term savings, it’s great to keep your money in a KiwiSaver balanced or growth fund or similar, where you’ll get higher average returns. But those returns can vary widely.

A reader we’ll call Anne — a keen member of KiwiSaver — wrote to say, “I can afford to contribute a bit more to KiwiSaver, and I’m not sure whether I should raise my contributions to 8% or put this extra money (another $60 per fortnight) into my mortgage.

“Is it as easy as comparing the return from KiwiSaver (currently 9% in my growth fund — or about 7.5 per cent after fees and taxes) with the saving I’m making from paying off the mortgage at an extra $60 per week? My mortgage rate is 3.85%.”

If we apply the rule above, it seems that Anne should put her money into KiwiSaver.

But there’s no way to predict future KiwiSaver returns.

In Anne’s growth fund, which mostly invests in shares, the return might continue for a while at its current very healthy level, or even higher.

But it could easily drop, and in some years it will be negative, with her balance falling. In those years she will wish she had put the extra money into her mortgage.

Over the long run, the government has calculated that the average return on KiwiSaver growth funds will be about 4.5% after fees and tax.

So we’re weighing up a somewhat higher but variable KiwiSaver return versus what amounts to a guaranteed return of 3.85% for reducing the mortgage. Anne might be okay with the higher risk, and put her extra money into KiwiSaver. Others might prefer the lower-risk option of extra mortgage payments.

The psychological side

People often say it feels great to get rid of debt. There’s security in knowing you own your home outright. And if you or your family get into financial difficulties in the future, you can probably borrow against your home again.

Conclusion: It’s always best to put enough into KiwiSaver to get the maximum from the government and your employer. But beyond that, most people will prefer to get rid of the mortgage as soon as possible. Once you’ve done that, you can get into really serious retirement saving.

Footnote: Beware of mortgage penalties

If you have a fixed-rate mortgage, you may be penalized if you pay off extra before the term — typically one to five years — ends.

Check with your lender. They may permit small extra one-off payments, or maybe you can raise your regular payments if you commit to the higher amount for the rest of the term.

But if you face a stiff penalty for making extra payments, you’ll probably be better off putting that extra money into a bank savings account or term deposit until the term has ended. You can then reduce your mortgage with no penalty.

Ask Mary

Have a question or concern about saving or investing for Mary? Email [email protected], subject Money. Letters cannot be answered personally. If your topic is chosen you will receive a copy of Mary’s book, Rich Enough? A Laid-Back Guide for Every Kiwi.

This column is supported by the Financial Markets Authority to encourage women to take an interest in KiwiSaver and investing. Visit fma.govt.nz for more information. Mary’s views do not necessarily reflect those of the FMA.

Mary Holm is a freelance journalist, a director of Financial Services Complaints Ltd (FSCL), a seminar presenter and a bestselling author on personal finance. From 2011 to 2019 she was a founding director of the Financial Markets Authority. Her opinions are personal, and do not reflect the position of any organisation in which she holds office. Mary’s advice is of a general nature, and she is not responsible for any loss that any reader may suffer from following it.