The Question
I’m in the very fortunate position of having inherited £80,000 recently. I own a property worth £340,000 and I have £150,000 left to pay on the mortgage. I’m two years into a five-year deal.
Having come into such a substantial amount of cash I am wondering whether it would be prudent for me in the long term to pay off a big chunk of the mortgage or to put the money into a fixed savings account.
The way I look at it I’d be investing the money either way – one way it’s going into my home and the other it’s into savings. But would I be penalised by my mortgage lender for repaying a big chunk of my mortgage?
I’m in a quandary and would value some advice.
Niall’s Answer
The first thing to consider is whether the interest rate on your mortgage is higher than the rates being offered on deposit. Typical rates at present are up to 4.8% on a one-year term deposit, with two-year terms typically offering up to 4.6%, which is a sign that lenders anticipate interest rates to fall within the next two years.
If your mortgage rate is higher, then you should consider paying off a chunk to save on the long-term interest you will pay on the mortgage.
However, most lenders will normally only allow you to repay up to 10% of the mortgage balance each year without penalty whilst you are in a fixed term deal.
So, you could pay off 10% immediately and then earmark the next two years’ worth of 10%, which you could fix away for one or two years at time to get a good rate in the meantime.
Bear in mind you may also have to pay tax on any interest, generally a Basic Rate Taxpayer can earn the first £1,000 of saving interest tax free or it’s only the first £500 for a Higher Rate Taxpayer. £65,000 at 4.8% would generate interest of £3,120 per year, so a Basic Rate Taxpayer would have to pay £624.00 in tax for example.
You should therefore utilise your tax efficient ISA allowance of £20,000 each tax year wherever possible so that 100% of any interest is paid tax-free. Cash ISAs typically offer the same fixed rates as above, or even slightly higher with some providers.
It’s also prudent to retain an accessible emergency fund of ideally up to six months’ worth of your monthly outgoings, just in case of unexpected expenditure such as replacing the boiler or a car repair, or in the worst-case scenario of losing your job, to ensure you can still pay the bills.
Lastly, you could also consider long-term investments as an alternative to deposit savings, as these could potentially give higher longer-term returns. You should be looking to invest for at least five to 10 years.
As there are other factors to consider, such as risk to your capital and investment fees, you should seek independent financial advice to determine if this is a better option for your overall circumstances.
Niall Duffy is an independent financial adviser at Aberdein Considine Wealth
