Should we use a lump sum to clear our mortgage?
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Question
My husband and I have £51,000 left on our Nationwide repayment mortgage on a 2.5% interest rate. The mortgage is due to finish in 2020.
Following a pay-off from my husband's work we can afford to repay the mortgage in full. Is this the best thing we could do with the money?
We have no other outstanding debts, and we would still have about £120,000 left over to invest.
Answer
As the interest rate on your remaining mortgage is only 2.5%, you may think that paying this off won't provide you with the best return and that you should look at investing your money elsewhere.
However, paying an interest rate of 2.5% on a debt is equivalent to getting a return of 3.13% gross on a savings account for a basic-rate taxpayer, 4.17% gross for a higher-rate taxpayer and 5% gross for an additional-rate taxpayer.
It will be difficult to find savings accounts that produce a higher return than this, unless you lock your money away for a significant period of time.
Check out the best savings rates available
ISAs
It is possible to get tax-free returns from a savings account through a cash ISA. However, the annual cash ISA allowance of £5,640 for both you and your husband is considerably less than the amount you have to invest.
Also remember that only the first £85,000 you put into a bank account is protected by the Financial Services Compensation Scheme (FSCS) - unless it is a joint account where the guarantee doubles to £170,000.
The best long-term fixed-rate savings accounts
| COMPANY | ACCOUNT | RATE | INFORMATION |
|---|---|---|---|
| FIRSTSAVE | Five-Year Fixed-Rate Bond (Issue 1) | 3.05% | Operated online only. Minimum deposit £1,000 |
| VANQUIS BANK | Five-Year High Yield Five-Year Bond | 3.01% | Operated online. Minimum deposit £1,000 |
| DARLINGTON BS | Monthly Income Bond 1 | 2.95% | Operated in branch or by post. Minimum deposit £10,000 |
| SAINSBURY's BANK | Four-Year Fixed-Rate Saver | 2.6% | Operated online or over the phone. Minimum deposit £5,000 |
You should also remember that interest rates are at historic lows and are likely to rise in the future. If that happens, the interest you are paying on your mortgage is likely to rise much faster than the return on any savings accounts you may have.
You could try to achieve a better investment return by turning to the stockmarket, although this would involve more risk and the possibility that you might lose money, especially in the short term.
Therefore, if you are a relatively cautious investor, firstly check if there are any exit penalties for paying off your mortgage and, if there aren't, use this pay-off as an opportunity to become mortgage free.
Patrick Connolly
is a certified financial planner at AWD Chase de Vere.
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Your Comments
Patrick has given you well-balanced advice but the best solution depends on factors like your retirement status i.e. how much spare time you have and are prepared to devote to making your money work for you. Also, importantly, how quickly you would want to access it.
Paying off the mortgage is the most hassle free but by no means the best from an investment viewpoint. It is fairly easy and relatively safe to make more than 2.5% from an investment fund, and a lot more if you are prepared to study the stock market a bit and buy good blue chip shares when they are at a low due to some temporary factor.
However as you have an additional £120,000 a good bet is to buy a flat with a deposit of around £150,000 and an interest only buy-to-let mortgage (say £70,000 at around 4%), furnish it and rent it out. You can claim tax relief on the interest and the rent should cover both your mortgage repayments (with a bit left over for expenses) and in 2020, when your house mortgage is paid off, you can switch the buy-to-let to a repayment mortgage, or else sell the flat and go on that world cruise!
Your money will be “safe as houses” with the chance of some capital appreciation to boot. You should aim for a quality flat and furnishings that will attract professionals and use a letting agent to carefully vet prospective tenants and set up the initial letting agreement. Make sure the agent agrees to only charging commission on the first year of any given tenancy, not on-going, so if you get a long-term tenant you don’t have to keep paying commission. Most will agree as they are falling over themselves to get your business. If you do not want the hassle of doing the odd repair then take up a maintenance agreement for the utilities and white goods.
This is what I am doing with roughly the same figures and time scales and I can assure you it is workable but only if you have some income to live on for now. Then, after 2020, some additional retirement income for you will be assured.
The answer's horribly obvious by posing the question: Why do many building societies charge a penalty to liquidate prematurely the debt? And those that don't build an additional margin into the mortgage repayments should you have the option of an early repayment as a lump sum!
paul m worked flat out to pay lump sums of my mortgage for many years finished it 8 years early . now saving the majority of the money i used to pay mortgage with for a pathetic return. i ask my self is it worth it should i enjoy the money before its to late ie health as we get older?????
I have to admit to not being sufficiently financially literate to understand the answer to this question so I would be most grateful for some clarification. I too am considering paying off a £48,000 interest only mortgage which has 6 years left to run. My interest rate is somewhat higher at 4.5% - shockingly !! but due to certain circumstances I have not changed it - so should I pay it off or not? I understand that interest rates are likely to go up as well but is Mr Connolly saying that as it is unlikely to get a reasonable enough return from straight forward savings accounts and investing in the stockmarket has its risks by paying off the mortgage early one would get more value for their money as it were?
I paid off my mortgage in just this way. I have slept at night ever since. I owe nothing to nobody now. I can ride out any financial crisis that comes my way.
I would 100% agree with STEVEJH... I followed this route and am happy to say I can sleep at night.
