Helping you make the most out of your money
Helping you make the most out of your money
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Working out what to do with a big lump sum or a spare bit of cash is one of the nicer financial problems to have.
One option you have is to use the money to pay down your mortgage, which will save you money on your home loan every month.
Or you could invest, which gives you the opportunity to build a nest-egg through the returns generated by your investments, perhaps to help fund a more comfortable retirement.
Below, we explain:
If you’re searching for a mortgage, check out our mortgage comparison tool to find the best deal for you.
Before you pay off your mortgage or start investing, there are several factors to bear in mind.
It is important to have a rainy-day fund – money on hand in the event of a financial emergency. That could be anything from a broken boiler, to a big bill for car repairs, to losing your job.
For these reasons, experts recommend that you keep between three and six months’ worth of your salary in an instant access savings account.
We list the top savings accounts
You should also think about any other debts you may have, such as credit cards, overdrafts or personal loans.
The interest you will be paying on these is likely to be higher than the interest saved on your mortgage. The interest may also be higher than the returns you would get from investing.
By repaying these debts, you can still give your overall finances a boost. This is because less of your monthly income is needed to cover the repayments.
If you aren’t already paying into a pension, you probably should be.
Contributions to pension schemes benefit from tax relief. And if you have access to a workplace scheme, your employer will pay in too, making them a very cost-effective way to save for retirement.
This does also represent a form of investment, albeit a very long-term one, as your money will go into the financial markets.
Here are the best ready-made personal pensions.
Mortgage repayments are the biggest monthly expense for most homeowners. So it’s no wonder that many people ask if it is smart to pay off your mortgage early.
While using savings to pay off the mortgage early can ease quite a big burden, this is not a decision to be taken lightly.
There are pros and cons to consider which we outline below.
The biggest advantage of using savings to pay off all or part of your mortgage is the reduction it will bring in your monthly outgoings, leaving you with more spare cash.
By paying your debt off faster, you will also reduce the overall interest bill.
Take the example of a £200,000 loan with a 3.5% interest rate. Over 25 years, the total amount of interest payable would be £100,374.
But over a 15-year term, the borrower would only pay £57,358 in interest.
The downside to paying off your mortgage early is that, unlike money in a savings or investment account, your funds won’t be available for any unexpected financial needs, such as losing your job.
That’s why it’s vital you have enough money in emergency savings before overpaying your mortgage.
You should also find out if there are any early-repayment charges (ERCs) on your mortgage.
These often apply during any fixed or discounted period of a deal and are calculated as a percentage of the amount you repay. The bigger that payment, the more you will be liable for in charges.
ERCs are typically between 1% and 5% but may be tiered: they usually start high and fall over time. For example, it might be 5% in year one but drop to 1% in year five.
For a repayment of £50,000 with an ERC of 3%, the total fee payable would be £1,500.
Depending on your circumstances, it may still be worth paying the ERC.
In other words, the saving on the mortgage repayments outweighs the charge. But it’s an important point to factor into your decision.
We have a guide to paying off your mortgage early
If you have grand plans for your future or simply want greater financial security, investing any extra cash can be a very sensible strategy.
But there are risks to bear in mind too which we outline below.
If you invest then, over time, it is likely that your money will grow much faster than it would if you left it in a savings account paying a low interest rate.
To really harness the power of the stock market and enjoy the benefit of compounded returns, you need to leave your money invested for a minimum of five years but ideally ten.
Another advantage to investing is that you don’t have to lose access to that cash if you need it in an emergency.
Whether you have invested in a mutual fund (where your money is pooled with that of other investors and managed on your behalf), or purchased shares directly, you can sell your investment if you need to.
Paying more into your workplace pension is also a form of investing.
In this case, you will get the added benefit of tax relief on your contributions. And, if you are in a workplace scheme where your employer matches increased contributions, they will pay more too.
Although this could be an excellent way to boost your retirement pot, the downside is that you won’t be able to gain access to it until you turn 55 (rising to 57 from 2028).
When you overpay your mortgage, you will get the benefit of an instant boost to your finances. Your debt will shrink straight away and you will have more disposable income.
The catch with investing is that returns are not guaranteed.
Much will depend on the performance of the investment you choose – and even if the long-term growth potential is good, you could still suffer short term losses.
In other words, if you really want to see your money grow, you need to be prepared to tie it up for a longer period so that the investment can ride out market downturns and benefit from the good times.
If you’re new to investing, we have a guide for beginners.
There are also charges associated with investing – from the platform you use to buy investments, to the management of the funds.
Then there is the time and effort required in choosing the right investments for you.
We can help you out by listing the best stocks and shares ISAs.
What is right for you will depend on your own financial circumstances, as well as your goals and priorities.
For many people, it will arguably be an emotional decision as much as a financial one.
It might be that you dream of being mortgage-free. Or you may be perfectly comfortable paying down your home loan but also the relish the idea of growing your money on the stock market.
So long as your wider finances are healthy (that is, you don’t have huge debts to pay off and you have built up a decent emergency fund) then both can be sensible options.
Working out whether to invest or pay off your mortgage doesn’t have to be an either/or choice.
By paying off your mortgage early, you could use the money you save each month to invest and build your future wealth.
Drip feeding money into an investment could even be a sensible idea given that investing a lump sum is generally considered higher risk than regular investing.
This is because you could lose a significant amount, on paper at least, if markets fall shortly after you invest. By putting in a smaller amount on a monthly basis, this risk is reduced.
Regular investing also means you get to take advantage of pound cost averaging. When markets fall, you are able to buy more units with your money. This gives you more growth potential when the stock market bounces back.
For many people, this can be a lower-risk and less stressful way to invest. And depending on the markets, a more profitable one too.
Or you could also decide to use some of the lump sum to reduce your mortgage and use the rest to invest.
We explain more in our beginner’s guide to investing. You can also find out how to invest £50,000.
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