Hey OP
Firstly, congrats; am super happy for all of you
Secondly, please feel 'honoured' as I haven't posted for aaaggggggeeesss as was (genuinely!!!) bloody addicted to MN
However... I've seen thread and can't cut & run (although I'm not sure you'll love what I'm going to write!)
I I were advising you professionally, then the below (will even bullett it report stylee for you 
- then THIS is what I would advise.
1: You are in an amazingly fortunate postion, do NOT fuck it up! (No, I wouldn't write that in a proper professional assessment BTW!)
2: You've been super clear that, micro (monthly) and macro (overall), that you are verrrreee close to the wire (window cleaner, "don't even have spare £100 etc").
3: Given that, that shapes your choices (or rather, what you should actually DO..) HUGELY.
4: You have £40k equity alongside a mortgage of £195. That is a, frankly terrifying and even more so in today's climate, a pretty perilous ratio. Bluntly put, your equity is less than 20% and your mortgage a shade over 80% of your home's value.
5: Putting together points nos. 2 & 4 paints a reality of you being very close to shit street (no, I wouldn't use that term in a report either!) in event of DH losing job, or one of you falling ill. You would or could lose your home in a matter of few short months if anyting like that occured.
6: Before you spend anything, you MUST, as others have said, check the tax position to ensure you don't spend it and then find yourself in debt to HMRC for CGT (Capital Gains Tax).
7: Before you ACCEPT the money into one of YOUR 'named' accounts, then ditto re above if you are in receipt of tax credits etc.
- Thereafter, what I would advise is that you do a split of splurge and sense.
- I'd 'allow myself' (in your overall financial position as described by you) 10% of it, so £3k on 'fuck it' money - IE the 'splurge' bit. I'd aim to use that on something that CONTINUES to gift you 'splurge' fun. IE, I would go nuts on the very best and most lux set of camping equipment possible (remember to factor in costs of trailer and tow bar!), as THAT would be the self-gift that keeps on giving - ESP. with 2 very young DC's. Did this when mine were younger and once even travelled Europe for 4 weeks with them and had a total ball which, even though they have been on way more expensive 'single' holidays since, they DO remember as THE BEST TIMES THEY EVER HAD. So in one fell swoop, you will have secured your family holidays for a pretty long time.
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Would echo (with a bloody loud speaker emocion if MN had one!) what other posters have said about 'emergency' money. General rule of thumb is that if anyone possibly CAN, then they MUST have 3-6 months of their 'normal' living costs in an account. Your best bet would be a high interest (this is though a very relative concept at the moment) account but which also is accessible - do NOT tie this 'chunk' of cash up in an account that will penalise you if you DO need to access it.
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Would echo (again..) other posters who have said use the balance after the splurge and the emergency account (I obviously don't know how much that amount would be as don't know your normal monthly income and outlay) to draw down the mortgage. SOLE caveat to that would to check that you won't be unduly penalised for that, although would add that even if T&C's of your mortgage say you WILL be, then speak to someone senior from your Lenders as sometimes they will be flexible.
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Given the potential tax issues, would where poss, get the 'givers' to pay as much as poss direct - IE bypassing your current account/s - so if doing say the camping thing, get them to directly pay it. My guess is even if they are giving it to you to help solidify your future, they will understand that splurge, ESP. as it itself is an ongoing investment in terms of holidays for you all (& the savings you will make by NOT having to pay for the holidays you might have tried to take).
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Would caution you to think carefully before entering an 'attachment account'. They do work brilliantly but ONLY for those who maintain their normal monthly expenditure (as the 'access' works both ways, IE have seen people who have actually ended up increasing their mortgage as have seen the 'balance' on that account as 'spendable' income).
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Emphatically would take out life insurance (& also use some to fund drawing up a will if you/DH have not yet done so).
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Under no circs would I advise you to even think about buying a flat for Buy to Let. Bluntly, you can't afford it AND it's risk-laden
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The only other option I would suggest investigating other than using the amount above for drawing down your mortgage would be looking into an extension, but ONLY if it is an extension that - as an absolute minimum - adds the same value to the house as the amount of cash you'd spend on it (the ideal, obviously, being an extension that DOES actually ADD value as opposed to being cash neutral as per above). There are so many house re-modelling options that do NOT even end up cash-neutral, I.E. the added value being LESS than the amount spent on it, so do your homework first via 3 or 4 of your local estate agents AND stalking Sarah Beeny
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Lastly, beware of going to an 'independent financial advisor' - one, as it itself costs money [I know, no shit Sherlock huh?
] and two, many of them are NOT 'independent' anyway, and 3, a fair few of them are not exactly great (no offence to anyone on here who IS a financial advisor and IS a good one!)
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In summary, do NOT do anything rash - other than the amount you decide IS your 'fuck it' fund to splurge with - and would suggest you see this as not just the awesome gift and opportunity it is, but also as your opportunity to get more financially savvy. Don't be scared to do that (know sounds like dumbest statement ever, but reality is that many peeps ARE 'scared' of learning about finances etc and see it as some giant brick wall when it's really not. Is exactly the same as any other subject that any of us might not know much about, as is the solution - IE go learn it!)
And VERY lastly, your new best mate here is going to Martyn Lewis's site www.MoneySavingExpert.com - there is literally NO financial subject or aspect that you won't be able to either learn or get advice on there.
Good luck (& congrats again!) x