Mortgages v super, the battle of the giants
David James |
21 May 2015
The statistics are clear. The residential property market in Australia is worth $5.5 trillion. Superannuation is over $1.8 trillion. The stock market is over $1.6 trillion (with a lot of super money in it) and the commercial property market is $700 billion. So the dsicussion over being able to use the super guarantee to pay off mortgages brings into conflict the two biggest pools of capital in the country.
Business Spectator is citing research that suggests using the money to pay off mortgages leads to a better outcome:
"If Australians were allowed to divert their superannuation guarantee contribution -- that’s the 9.5 per cent of salary employees are required to pay into superannuation -- to pay off mortgages, most would see their wealth increase by $100,000, preliminary ANU modelling concludes.
For an average income earner, wealth would jump to $450,000 from $350,000. It looks even stronger if compared to cash returns rather than the balanced super portfolio used in the modelling.
“We get a difference in relative wealth that’s quite substantial,” says Timothy Higgins, who along with Aaron Bruhn and Ruchen Han authored ‘Is super always the best option?’, which was presented to an Actuaries Institute summit in Melbourne this week."
Here is a graph version:
Given the distortions in Australia's housing market, this comment is not terribly surprising. Paying off mortgage debt guarantees a return on the money (that is, the mortgage interest rate). That return may be harder to guarantee on super, although over the longer term they should be comparable.
So paying down debt, especially when that debt is heavy, is certainly a defensible strategy:
"Bruhn and Higgins are at pains to insist their idea is not about accessing super for first home buyers. It is about redirecting funds to an existing mortgage, not enticing newbies to the current property market.
And besides, New Zealand, Singapore, China and Malaysia already allow some withdrawal or redirection of retirement savings to home loans.
“Our preliminary modelling suggests it is extremely welfare enhancing for individuals at low cost to government,” the researchers say in their presentation.
“If the purpose of super is to increase our wealth and financial independence at retirement, then shouldn’t the rules change if it means substantially better financial outcomes for retirees? “"
Interestingly, the modelling assumes that the return on super will be lower than the mortgage rate, which skews the argument in favour of paying down mortgages rather than saving for the future with super:
"The base modelling centres on a scenario of a 25 year-old, with a starting gross salary of $52,584 and a 30-year home loan of $300,000.
The super return modelled is 5.1 per cent a year, and the mortgage rate 7.6 per cent, which Higgins and Bruhn say are 20-year historic rates.
All this leads to a quarterly repayment of $6,237.
The team set out to ponder whether savings from lower accrued interest, and extra contributions made after the mortgage is repaid, offset the reduction in contributions while the mortgage is being repaid. This of course depends on the gap between mortgage rates and superannuation returns, salary, age, and the term and size of the property loan.
The method compares apples with apples by assuming retirement and access to superannuation at age 60, the same disposable income throughout working life until retirement, and that after the mortgage is repaid, the salary that was used for repayments is now used to make superannuation contributions.
Contributions can be concessional or non-concessional , with a $30,000 cap, and an assumption concessional contributions are maximised before non-concessional contributions are made.
The model then compares wealth (in 2015 dollars) at age 60 under both options -- that is super minus outstanding mortgage. Other sources of wealth, such as the age pension, are ignored.
The diversion into mortgage repayments reduces the term of the mortgage and provides large savings from lower accrued loan interest, though there is no growth in the superannuation balance while the mortgage is being repaid, and there are high contributions (and superannuation balance growth) once the home loan is paid off.
This is just one model, whose assumptions are contestable. It only looks at individuals, for instance. But it does underpin one point. Paying down mortgage debt is a highly efficient way of managing money. As Business Spectator suggests, the banks are the winners and the mortgagees are the losers in the inflated Australian housing market.