Should You Use a Cash Windfall to Pay off Mortgage Early or Invest? Using Ms Smith dilemma as a case study, Quick Loans Express explore whether she should retire and use the money to pay off her mortgage or invest it. Read on to find out what she should do!
In this article, Quick Loans Express, an online fast loans lender, use a case study to examine the wider issue of whether it makes financial sense to use a lump sum to pay off a mortgage. You’ll be able to read about:
Pay Off Mortgage Early or Invest? What to do?
We begin by explaining the present financial situation of Ms Carol Smith. We look at the factors she needs to consider before deciding what to do with her windfall of £110,000, and finally give her advice. Should she pay off mortgage early or invest? Let’s find out!
Case Study: Ms. Carol Smith – Her Present Financial Situation
Ms Carol Smith is 55 years old and has worked at various roles in the Metropolitan Police over the past 28 years. Despite changes in public sector pension schemes in 2015, her years of service and age mean that she could choose to retire now if she wanted.
As part of her police pension scheme, Ms Smith would be entitled to a cash lump sum of £110,000. She would also receive a monthly pension payment of £1,250 (after tax). However, she wouldn’t be able to access her state pension until she reached state pension age. This could mean a wait of at least 10 years.
Ms Smith has an outstanding mortgage of £119,000 on her four-bedroomed home, which is valued at £490,000. Her monthly mortgage payments are £900. She is on a fixed rate mortgage of 2.99%, and it is due to expire in November 2019.
Other Debts, Income & Savings
Apart from her mortgage, Ms Smith has no other outstanding loans or consumer credit debt. She has £10,000 in ISA stocks and shares. She also has a lodger who contributes towards her mortgage repayments by paying her £650 rent every month.
Ms Smith’s Dilemma – Pay Off Mortgage Early or Invest?
Ms Smith’s dilemma is whether to retire immediately and use the lump sum from her pension plus her £10,000 of savings to pay off her mortgage.
Although this seems ideal as it means she would start her retirement debt-free, it would also leave her with no emergency fund to fall back on. If she needed money in a hurry, she would have to use expensive high-cost credit facilities like her credit card.
Another factor to consider is the issue of her mortgage. Are there any reasons not to pay it off?
What should You Consider before Paying off a Mortgage?
Before using her lump sum and savings to pay off her mortgage, Ms Smith should first go through its terms and conditions. Many mortgage providers allow a certain amount in overpayments every year, but have an early repayment penalty. This means that paying back her mortgage in full could cost considerably more than the £120,000 she has at her disposal.
In order to calculate whether it is worth it, she should subtract the interest rate earned on her lump sum from the interest she would pay on her mortgage until November 2019. She should then compare this figure to the early repayment fees charged by her mortgage provider.
If it isn’t worth her while to pay off her mortgage, what else could she do?
What are her Alternatives to Paying off her Mortgage?
With her fixed rate mortgage due to expire in November 2019, it might be a better idea for Ms Smith to adopt a wait-and-see policy. So what could she do with her lump sum in the meantime?
One idea is to consult an FCA-approved independent financial advisor to discuss the possibility of investing her money. Investment may bring better returns than a savings account, but she would have to weigh up the risks. There’s no guarantee that the returns on her money will be higher than being kept in a savings account.
Looking around for savings accounts, preferably with an interest rate of higher than 2.99% (to cover the interest she’s paying on her mortgage), is another risk-free possibility she could consider. Because of the size of her lump sum, she should divide the money between two banks or building societies. In this way, she will benefit from the Financial Services Compensation Scheme which only guarantees deposits up to £85,000.
Although this means that her monthly expenses won’t come down, it will give her the opportunity to re-mortgage with a much better deal. However, she should also take into account the risk that interest rates will have increased by then.
Early Retirement – Is it Advisable?
Although Ms Smith is eligible to take early retirement, this doesn’t necessarily mean that she should. One advantage of waiting is that this would boost the pension package she can expect when she retires.
With recent changes to the state retirement age, it might be over a decade before she can receive her state pension (currently £165 per week). Before she makes the decision to retire, she should check her National Insurance records to make sure that she has made enough contributions. Without her state pension and after paying off her mortgage, she’ll be left with a monthly income of £1,900 (her pension plus rent from her lodger). Only she can judge whether this would be enough to live on.
Conclusion – Pay off Mortgage Early or Invest?
The best advice we at Quick Loans Express, a responsible direct loans lender can give Ms Smith is to defer her retirement until her fixed rate mortgage expires at the end of 2018. During this period, she should make as many mortgage overpayments as she can to bring down the sum that she owes. She should also try to set some money aside so that she has an easily-accessible emergency fund.
Nearer the time, she should go through the figures again. With overpayments and a larger pension pot, she should be able to pay off her mortgage with the lump sum, and still have some money put by as a cushion.
The case study of Ms Smith illustrates how many factors there are to consider in long-term financial planning. It also shows that any decisions you make aren’t set in stone, and they have to be regularly reviewed to take account of your changing circumstances and external factors. So now what are you going to do with your windfall – pay off mortgage early or invest?