Usually any form of debt reduction is good. The less debt you owe, the less interest you pay. So home-owners often ask the question, should I focus on paying down my mortgage or contribute money into KiwiSaver?
At the moment, mortgage interest rates are around 2.6 percent per annum and the average “Growth” KiwiSaver fund is averaging around 8 percent per annum.
That means, reducing your mortgage by $1,000 would save you $26 per year in interest. However, putting that same $1,000 into KiwiSaver would bring you $80 per year in profit. In other words, you would come out $53 better off if you invested the $1,000 into your KiwiSaver instead of your mortgage.
However, it’s not quite that simple unfortunately. After you buy your first home, you don’t have access to any profit from KiwiSaver. In other words, that money is locked away until you reach retirement age - meaning you still have to find additional money to pay the interest on your mortgage.
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There’s one other thing to consider if you’re a salaried employee. Your work should be matching your KiwiSaver contributions up to a certain amount. The amount varies; most employers will be on 3 percent but I’ve seen it as high as 10 percent. This means, if you put in 3 percent of your salary into KiwiSaver, your employer will also put in a matching amount but minus tax. If 3 percent of your salary was $1,000 (just to use easy numbers), your employer would also put in around $700, which is your $1,000 minus tax. You might then average around 8 percent return on the total amount meaning the $1,000 you put in has turned into $1,836. Over $800 more than the $26 you would have saved on your interest rate!
Note that I said “you might average 8 percent” because this is where the risk lies. Sometimes KiwiSaver balances have a negative return - like 3 months ago - and sometimes they have a positive return. It’s hard to know when either will occur. But if you reduce your mortgage, you will always save the interest rate you are paying, guaranteed!
So what is the answer? Should you pay down your mortgage or contribute to KiwiSaver? As always, everyone should seek financial advice for their personal circumstance but a good place to start would be to consider contributing money into KiwiSaver up to the maximum that your employer is matching your contributions (turn $1,000 into $1,836).
After that point, you could consider paying extra into your mortgage as the reduction in mortgage will mean more of your income is available after every pay day. Even though mortgage interest rates are low, there is no telling when they will go up again, and paying your mortgage now will save you a lot of money in the future.
- Rupert Gough is the founder and CEO of Mortgage Lab and author of The Successful First Home Buyer.
