Upside to paying off the mortgage
Given the uncertainties surrounding government policies and future investment returns, there's understandable confusion concerning the best financial planning options.
Historically low interest rates have taken much of the pressure off paying off the home mortgage quickly. But after-tax returns from paying off a mortgage of around 4 percent or slightly more a year compare favourably with the returns on comparable safe investments.
Term deposits in personal names are yielding after-tax returns of 2 percent or even less for investors on higher marginal tax rates.
Apart from the attractive return, paying off a house mortgage provides additional financial planning advantages. These include the ability to redraw part of the loan to meet unexpected expenses and even better, borrowing against the house on a tax-deductible interest basis to buy investments.
Our income tax system is designed to provide unlimited assistance to investors. So paying off a house loan quickly and then re-borrowing using the home as collateral to buy investments is a very tax effective strategy.
With interest on investment loans tax-deductible, there's little incentive to pay off an investment loan unless this is the only outstanding debt. Even then, especially for older people close to accessing super, building up assets in super can be a better option.
In terms of financial flexibility and certainty, the superannuation preservation rules and the prospect of further changes to tax arrangements make voluntary super contributions unattractive for younger and even middle-aged taxpayers. These age groups will also benefit from negotiating with employers to keep compulsory contributions to the minimum required by the Australian Tax Office. Even though there's more income tax to pay, receiving extra salary in lieu of more super will help pay off mortgages or fund negative-gearing losses on investments.
For these age groups, the tax assistance for negative gearing exceeds that available for investments in superannuation. Especially when there's collateral, such as equity in the family home, available to assist heavily geared borrowings, the amount of money needed to gain a large negative-gearing tax deduction is much smaller than that needed to gain a comparable tax benefit from super.
High levels of borrowing involve considerable risks for investors and need to be closely considered to ensure there are tangible returns. There's a need also to be aware of the downside of the capital gains tax that will be payable when geared investments are sold.
Consequently, superannuation is a lower-risk option, but only if the investor can be certain that access to the funds will not be needed before retirement.