By Ed Magnus For Thisismoney.co.uk
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My husband and I have just been gifted a life-changing £500,000 sum by my father-in-law who has just sold his business.
Our first wish is to clear our £220,000 outstanding mortgage, but this is fixed until May 2025 and there is an early repayment charge.
We have the option to pay back 10 per cent each year, fee-free, up to 31 December each year. If we decided not to pay off the whole mortgage at once, we could make these overpayments and put the rest of the £500,000 in a savings account, earning savings interest to offset the interest we would still be paying on the mortgage.
Given our timeline we would be looking at two-year savings bonds – but there would be an extra nine months at the end before we could pay off our mortgage.
A good problem to have: £500,000 is a life-changing amount of money, but it does mean there are big financial decisions to make
Finally, even after paying off the mortgage we will have a lot left over. We both have decent incomes and a rainy day savings buffer in case of emergencies.
Should we invest the remainder of the money in the stock market, or drip feed it from savings into investments over the next year or so?
We are worried that given the current uncertainty and economic climate it would be a major risk to invest all at once.
Ed Magnus of This is Money replies: This is a life changing amount of money, but it does raise the stakes in terms of financial planning.
When it comes to your mortgage, as you say, you have a couple of options.
The first is to repay the whole mortgage now, and take the early repayment charge hit.
Alternatively, you could pay just the permitted 10 per cent back for the next two years, and use a best buy fixed rate savings account to offset, or even perhaps beat the extra mortgage interest costs you will incur by keeping your mortgage for longer.
You would then pay off the mortgage at the end of your current fixed deal without any charge.
Some may be tempted to invest the money rather than save. However, a two to three year timeframe and the fact that you are effectively putting money to clear the mortgage on your home – a £220,000 asset – at stake would make that a risky strategy.
As paying off your mortgage is your number one priority, it’s worth at least considering doing so early and working out what the hit would be vs the interest you would otherwise be charged.
Typically for a five year fixed rate mortgage, the lender will charge 5 per cent of the total mortgage amount if you pay off in the first year, 4 per cent in year two, down to just 1 per cent in the final year.
As you are in your third year, your early repayment charge might therefore be 3 per cent of the outstanding mortgage amount. In your case this would mean paying £6,600 to pay off the mortgage early.
However, this is not always the case, and lenders have different approaches. Santander, for example, fixes the early repayment charge at 5 per cent of the total mortgage amount for the entire five year period.
Check your mortgage contract or ask your lender directly what your early repayment charges are, so that you know the details.
Balanced against this is the extra cost of paying interest on the mortgage over the next three years if you just keep payments the same as now, again your lender should be able to help with this information. They may also be able to give you the figures on if you make 10 per cent overpayments below any early repayment charge trigger threshold.
Do your sums: Whether using a savings account to offset the mortgage costs is a good plan will depend on whether the interest earned is more than the interest rate cost of the mortgage
Paying off a mortgage is a big financial milestone, and one many homeowners are eager to reach as soon as possible. So, if you’ve got the money to do so then it will be tempting.
But there is no denying that the most financially prudent course of action would be to avoid paying any unnecessary early repayment costs.
So, storing your mortgage-clearing lump sum in a savings account, perhaps a two-year fixed rate bond deal, followed by an easy access, notice account or six month fix for more flexibility towards the end, could be a savvy move.
Fixed deals see savers lock away their cash for a certain period in exchange for better interest rates, and with your mortgage deadline almost three years away, this fits your circumstances well.
One thing to be aware of is that your money will only be protected up to £85,000 per bank by the financial services compensation scheme – or £170,000 in the case of joint accounts.
So, if you choose this option you will need to to set up savings accounts with a number of banks, in case the worst happens and one goes bust.
One way to manage this problem is by using an online savings platform. This allows you to bring all your accounts into one place and spread the FSCS protection.
They don’t offer every single account on the market, but they do offer some of the most competitive rates. Examples include Raisin UK and Hargreaves Lansdown’s Active Savings.
Mortgage freedom: Although repaying the mortgage early may be tempting it may end up costing you dearly due to early repayment charges.
When it comes to savings rates, there isn’t much benefit to be had from fixing for longer than a year or two at the moment.
In This is Money’s independent best buy fixed rate savings rate tables, the best one year deal is offered by Virgin Money and pays 3.32 per cent. The best two-year deal, offered by SmartSave Bank pays 3.51 per cent, whilst the best five year fix pays 3.61 per cent.
The best one-year fixes have been heading upwards over the past year and are expected to continue to do so as the Bank of England continues to raise the base rate in its bid to curb inflation.
A one-year deal gives you little more flexibility with that cash, in case something changes in the meantime.
Equally if you’d prefer to fix for two years, at least you know you’re making more from savings than you’re losing by continuing to pay interest on your mortgage.
One thing you need to take into account is the fact you each have to pay tax on the savings interest you earn.
If you are a basic rate taxpayer you get a tax-free allowance of £1,000 per year. If you’re a higher rate taxpayer you get a tax-free allowance of £500 a year. Additional rate taxpayers get no savings allowance.
If both you and your husband are higher rate taxpayers, this will mean that after the first £1,000 each year, the best one-year fixed savings account paying 3.32 per cent will effectively be earning a rate of 1.99 per cent after tax.
If you are basic rate taxpayers, a 3.32 per cent rate will effectively be reduced to 2.66 per cent after tax.
Beware the taxman: When looking at headline savings rates, it’s important to factor in that you’ll get taxed on the interest you earn once you breach your personal savings allowance,
So you’ll need to factor in whether, after tax, this trumps your mortgage costs.
You will also need to keep some cash in a notice account or one of the best easy-access savings rate accounts to allow you to make the 10 per cent annual mortgage overpayments.
The best paying easy-access account currently pays 2.1 per cent and will allow you to withdraw funds as and when you need to overpay the mortgage.
To give you the best advice, we asked four experts for their opinion: Tracy Crookes, chartered financial planner at Quilter, Laith Khalaf, head of investment analysis at AJ Bell, Laura McLean, chartered financial planner at The Private Office and Anna Bowes, co-founder of Savings Champion.
Laith Khalaf replies: I totally understand that desire to get that mortgage monkey off your back, and while you might use the 10 per cent fee-free repayment option, it probably doesn’t make a great deal of financial sense to start incurring large fees for early repayment.
Instead you are probably better off waiting until the mortgage matures, and paying it off then.
That’s particularly the case because, at the time you set up this mortgage, you probably did so at much lower interest rates than are available in the market at the moment.
So, actually you may find that by waiting, not only do you avoid fees, but you also get a higher incoming rate of interest on your cash in the bank than the outgoing interest you are paying on your mortgage – but of course this depends on the precise deal you got.
Anna Bowes replies: You can currently earn around 3.5 per cent on a two-year fixed deposit account.
Many fixed term bonds allow you to choose if you want to have the interest paid out each year (if you wanted to earmark some of it to over pay the mortgage), or you can roll it over until maturity which means you can earn interest on interest.
As the amount you are looking to deposit exceeds the Financial Services Compensation Scheme protection limit of £85,000 per person, you may prefer to open at least two accounts (if you are happy to deposit funds in joint names) or three, if you are keeping the money in only one of your names.
Once the accounts mature, you could then find competitive easy-access or notice accounts to hold the funds until the end of the mortgage term in May 2025.
Chartered financial planner Laura McLean replies: Investing the balance into the stock market should only really be considered where you have at least a five-year timeframe, to avoid the unwanted scenario of selling at a loss, if there were to be falls in investment markets just before the funds were needed.
It is essential to keep back enough cash for the short term and emergencies – at least six to 12 months’ expenditure, plus an additional buffer for any unforeseen events.
If you have not invested before, it is important that you are comfortable with the bumps in the road associated with investing, which can be a shock to those used to savings accounts where the capital value does not fluctuate.
Provided you can tolerate falls as well as rises in the value your investment, particularly over the short term, equity investment could provide you with opportunities for long-term growth that will be better than cash and hopefully beat inflation over time.
The ups and downs: Investing the remainder of the money will make sense in the long-term but the couple must expect their investment to move up and down in value during that time
Financial planning can help you grow your wealth, sort your pension, or make sure your finances are as tax efficient as possible.
A key driver for many people is investing for or in retirement and inheritance tax planning
If you are looking for help sorting your finances and want to work out whether you need advice, planning, or coaching, the following links can help you understand more:
> Financial adviser, planner or coach – what’s the difference?
> Financial advice: What to ask and how much it might cost
> Find a financial adviser service
Tracy Crookes replies: While you mention that you have an emergency fund, it might be worth having as much as 12 months’ net expenditure tucked away as this will give greater peace of mind and help to ensure investments will not need to be accessed too early.
In terms of the remaining £280,000 left over to invest for the long term, it will depend on your age but maximising your pension contributions should be top of the list.
How early you want to retire or reduce your hours will also dictate how you invest this money.
For example, you may want to consider an investment bond which would allow tax deferred withdrawals to supplement income in future if you wanted to work fewer hours.
You should also look to max out your Isa allowances, and investing via a stocks and shares Isa should give you the best returns if you invest over a long period.
You may also want to look into opening a Junior Isa and even opening a pension for your child. The longer money has to grow in the stock market typically the better.
You may also want to consider putting some money aside to support your children through school or university if you feel that might be an option for them.
Getting financial advice can help make sure that any investments fit your risk profile.
Laith Khalaf replies: You’re right to think about investing the remainder of your money, because you’ve got your rainy day cash fund sorted.
I would definitely advocate drip feeding this money in gradually as you suggest, and a year is a reasonable time frame which balances the need to get the money working hard with some common sense.
This is a good plan irrespective of the economic climate, because the market can be a capricious beast in the short term, even though it’s surprisingly reliable in the long term.
If you put the money all in in one go, and the market fell 20 per cent, over time it would no doubt recover – but that would still be pretty hard to swallow with such a large sum on the line.
It would definitely be better to hedge your bets and drip feed it in over a year, buying in at an average price for the market over the course of the next twelve months.
Laura McLean replies: Drip feeding money into the market can help to control volatility as you would be buying into the market at different price points. However, this could also work against you as there is the potential to miss out on some market increases whilst some of your funds remain in cash.
It is most important to ensure you remain invested over a long-term timeframe.
Tracy Crookes replies: Whether you choose to drip feed into the market using phased investments or invest all at once will be a personal choice.
It can be useful in an uncertain climate to drip feed, but it can go either way. The stock market carries inherent risk and choosing risk-appropriate investments is critical.
Laura McLean replies: In terms of the investments themselves, building a diverse portfolio is key and this should align to your tolerance to investment risk and the investment time horizon.
For example, long term adventurous investors would likely have high allocations to risk assets such as equities, with shorter term or more cautious investors diversifying their portfolios with holdings of lower risk assets that provide downside protection, such as bonds or absolute return style funds.
Along with investment performance, making sure you use the tax allowances available to you can help to boost your returns.
For example, funding your Isas and pensions will provide tax-free growth whilst any income and gains within a general investment portfolio can be offset against your annual dividend and capital gains tax allowances.
Investing online is simple, cheap and can be done from your computer, tablet or phone at a time and place that suits you.
When it comes to choosing a DIY investing platform, stocks & shares Isa or a general investing account, the range of options might seem overwhelming.
Every provider has a slightly different offering, charging more or less for trading or holding shares and giving access to a different range of stocks, funds and investment trusts.
When weighing up the right one for you, it’s important to to look at the service that it offers, along with administration charges and dealing fees, plus any other extra costs.
To help you compare investment accounts, we’ve crunched the facts and pulled together a comprehensive guide to choosing the best and cheapest investing account for you.
We highlight the main players in the table below but would advise doing your own research and considering the points in our full guide linked here.
>> This is Money’s full guide to the best investing platforms and Isas
Platforms featured below are independently selected by This is Money’s specialist journalists. If you open an account using links which have an asterisk, This is Money will earn an affiliate commission. We do not allow this to affect our editorial independence.
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