Q&As
- Is it better to repay your mortgage or invest in a work super scheme?
- Website with interest rate info.
QI am a 42-year-old single parent, just about to re-enter the fulltime paid workforce. My salary and child support, combined, will come to around $60,000 gross. I don’t expect a significant increase in my income in the next few years.
I own a home in an appreciating area of Auckland. It is worth around $400,000. My total debt, all mortgage, is around $210,000.
I’ve worked hard at paying off my credit cards, store cards, student loan and car over the past few years.
My new employer runs a subsidised superannuation scheme. Given my age and my commitments, am I better to invest a little in the superannuation scheme, or to focus on reducing my debt levels?
ALet’s start with the basics.
Repaying high interest debt — if you have any — is pretty much always the best use of your money. But you’ve already done that. Good on you!
Generally speaking, repaying a mortgage comes next.
Getting rid of a debt on which you are paying, say, 8 per cent interest improves your financial situation in exactly the same way as owning an investment with a return of 8 per cent, after tax. In other words, stopping money from going out is as good as putting new money in.
There are, of course, investments with after-tax returns sometimes higher than 8 per cent. But any investment that pays more than mortgage interest — regardless of the level of interest rates and returns at the time — will always be risky.
Basically, you would have to invest in shares, property or higher-risk debentures, all of which might bring in more than 8 per cent, but they also might not.
Repaying your mortgage, on the other hand, is about as low a risk “investment” as you can find. It’s also easy, requiring no research. It seems the obvious choice.
There is, however, a counter argument that goes like this: It’s best to put most of your spare money into repaying your mortgage, but consider putting, say, $100 a month into a well diversified, low-fee share fund.
There’s a reasonable chance that, over the years, the average return on the share fund will be higher than 8 per cent after tax.
Also, it gets you into another type of asset, so you’re not concentrating only on housing. And there’s nothing like being invested in the share market for learning how it works, and how it goes up and down but always trends upwards over the long haul.
Once you’ve paid off your mortgage, you will then be readier to put more of your savings into the share fund.
Which is better: All mortgage repayments or a bit of share fund on the side? Whichever feels more comfortable.
In your case, however, there’s a complication. Unlike most people, you have the option of investing in a subsidised super scheme. And the subsidy makes all the difference.
Let’s say you have a choice of:
- Repaying an extra $200 a month off your 8 per cent mortgage, for 10 years.
That would improve your wealth by about $36,000.
- Investing $200 a month into the super scheme, which your employer matches dollar for dollar, bringing the total to $400 a month for 10 years.
Even if the return on the scheme was zero, that would improve your wealth by $48,000. And you can be certain you’ll do better than that over a decade.
What if the employer gives you 50c for every dollar you invest? Your $200 a month would then grow to $300.
That would still come to $36,000, after ten years, if the return was zero, and $46,300 if the return happened to be 5 per cent a year.
The results will be the same, comparatively, whether you put in just $50 a month or $5000 a month. To work through other examples, use the regular saving calculator on the Retirement Commission’s www.sorted.org.nz.
Of course, mortgage rates and investment returns will change over the years. But they will stay much the same relative to one another.
It’s hard to imagine a scenario in which a super scheme with at least a 50c-in-the-dollar subsidy doesn’t beat repaying a mortgage.
A final note: In the calculations, I have ignored inflation to keep things simple.
In this situation that doesn’t matter much, as it’s the comparisons rather than the absolute numbers that are important.
However, when you use the Sorted calculators, they suggest you use returns after inflation. Then, when you get a savings total of, say, $20,000, that means you will have savings that will buy whatever $20,000 buys today.
In the above examples we might use 5.5 per cent instead of 8 per cent for the real (inflation-adjusted) rate of interest on the mortgage.
That shows us that repaying the mortgage would improve your wealth by $31,700 in today’s dollars.
And we might use 2.5 instead of 5 per cent for possible growth on $300 a month for 10 years.
That would bring us to $40,800 in today’s dollars — still well ahead of repaying the mortgage.
QI remember about a year ago, the Herald’s website had a link to banks’ and other financial groups’ current interest rates.
I am keen to do a term deposit so I found that very useful to compare company to company. That site seems gone now?
AI don’t know what was on the Herald website. But the website I use for such info, www.interest.co.nz, is still there and still useful.
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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. Send questions to [email protected] or click here. Letters should not exceed 200 words. We won’t publish your name. Please provide a (preferably daytime) phone number. Unfortunately, Mary cannot answer all questions, correspond directly with readers, or give financial advice.