If you find yourself with a lump sum – perhaps through an inheritance, a bonus or because an investment has matured – you may be wondering what you should do with it.
One of the common questions that we’re asked is ‘should I pay off my mortgage with a lump sum, or should I invest it?’
As with all financial advice, there are pros and cons to both choices. However, before we consider the pros and cons of using a lump sum to invest or repay your mortgage, there are some other questions you should ask yourself first.
3 questions to ask before investing or repaying your mortgage
1. Do I have an emergency fund?
Experts recommend that you keep around three to six months’ salary in an emergency fund. This is an easy-access savings account where you can get hold of money quickly if you need it – for example, to replace your boiler or for car repairs.
If you don’t have an emergency fund, consider using some of your lump sum to create this financial safety net.
2. Do I have other debts?
If you have outstanding balances on a credit card or store card, or you have unsecured personal loans, then it’s likely that you’re paying a higher rate of interest on these borrowings than you are on your mortgage.
In this case, it may be a sensible choice to repay these debts off first, before you start thinking about making a capital repayment to your mortgage.
3. Am I contributing to a pension?
If you don’t already have a pension, or you are making less than the maximum contributions (typically 100% of your earnings or £40,000, whichever is lower) then it may be worth considering using some or all of your lump sum to make a pension contribution.
Pensions are an excellent way to save because of the tax relief you get from the government. So, if you do have a lump sum, paying into your pension might be a good place to start.
The pros and cons of repaying your mortgage with a lump sum
There are many complicated calculations that you can undertake to work out whether you will be financially better off by investing your money than you are paying off a lump sum.
In theory, if you can achieve a better return from your investment than the interest rate you are paying on your mortgage, then you could be better off investing. However, things are rarely that simple! Factors such as the type of mortgage you have, the term remaining and the type of investment you’re considering will all come into play, making an exact answer difficult to establish.
Firstly, if you’re considering paying a lump sum off your mortgage, you should establish whether you will pay any Early Repayment Charges (ERCs). If you’re on a special fixed, variable or tracker rate deal then it’s likely you will pay charges if you want to make a lump sum repayment to your mortgage.
Depending on your interest rate, ERCS can run into thousands of pounds and so this might influence your decision.
Even if no ERCs apply, paying a lump sum off your mortgage can be inflexible in that it can be difficult to get that money back in the future should you need it. You may then have to remortgage your home to get the money back, which can be a costly and difficult process.
There are advantages to repaying your mortgage with a lump sum. One of the most important is the psychological benefit of you feeling more secure in your home, knowing that you either have a much smaller mortgage, or that you own the property outright if you’ve paid off your mortgage in full.
If you have repaid your mortgage, then you will no longer have to make a monthly payment, and this could help you to budget if, for example, you’re heading into retirement or you anticipate a change to your income.
If you’re paying off a lump sum to reduce the size of your mortgage you typically have two choices:
- Keep the mortgage term the same and reduce your monthly repayments – paying a lump sum off your mortgage can help your cash flow on a monthly basis.
- Keep your monthly repayments the same and reduce the mortgage term – this will give you the security that your mortgage will be paid off more quickly than you originally anticipated.
The pros and cons of using your lump sum to invest
In a low interest rate environment, you may prefer to use your lump sum to invest. If you’re benefiting from a low rate on your mortgage – many deals are currently available at less than 2% interest – you may feel that investing your money for the long term may be a better option.
If you expect to invest for a long period, then there is certainly potential for growth. According to Vanguard, the average stock market return in the UK between 1997 and 2018 was 9.9% a year. This represents a healthy return over time, and certainly more than the interest rate you would currently pay on a mortgage.
Investing your lump sum can give you the ability to earn returns according to the level of risk you are prepared to take.
Of course, the value of your investment can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.
Investing your lump sum can be risky, and there are no guarantees.
One reason that you might not want to consider investing a lump sum rather than repaying your mortgage is if you are looking for a quick return. If your mortgage only has a couple of years left to run, it might not be suitable to invest for that short a period, as investments are typically recommended for the medium to long term.
Get in touch
If you have a lump sum and you’re not sure what to do with it, get in touch with us.
Every client’s circumstances are unique, and you will have different priorities, goals and circumstances to another investor. The right advice will depend on your specific situation and what your long-term plans are, and so it can pay to speak to a professional.
Please note: Your home may be repossessed if you do not keep up repayments on a mortgage or other loans secured on it. Think carefully before securing other debts against your home.
The value of your investment can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.