Coming into some money - pay off half of interest-only mortgage or invest so can eventually pay it off in full?

[FungalToeBogeyman]

We took out an interest-only mortgage pre-recession, when our circumstances were very different and we were in a position to save towards repayment.

A few years later, DP, who was a high earner, developed mental health difficulties which affected his ability to work. Now, I'm the main earner, and my job is much more modestly paid. So while we can afford the monthly interest payments, we can't put more than a few hundred away each month towards the eventual repayment. The outstanding borrowing is £260,000.

In a few months, very luckily, I'm due to come into some money, and it will be enough to pay off nearly half the mortgage – a bit over £100,000.

What I'm wondering is, do we pay off a huge chunk of the mortgage with this money or, where the interest we pay is very low (1% over base rate), would it be better to invest it and, by the end of the mortgage term (about 20 years), have enough (with average growth of 5%) to pay it off in full?

I like the idea of seeing the overall borrowing reduce by nearly half, and knowing that when interest rates rise, we'll be able to afford the payments comfortably. However, even with nearly half the mortgage paid off, we still won't have the means to repay in full simply by saving each month, especially when interest rates rise. Nonetheless, we want to keep our settled DC here if at all possible.

My financial adviser recommends investing the money, at least initially while interest rates are still low in relation to the return we could achieve by investing, but I'd just like to get a second opinion.

What do others think? What would you do?

Thanks.

Please if you are considering the BTL (which, as you can see, I personally think is insanity in your situation) consider the fact that for every £1 you can pay off your capital you are reducing the overall interest you will be paying during the life of the mortgage DEBT. Yes 1 percent is a very cheap loan. Its still a loan and it still needs paying off. Reduce it now and you'll be pleased you did when the interest rates go up again. More pleased than you will be when, in addition to the new higher mortgage payments, you are also worrying about whether your tenants have trashed the BTL, whether your might be asked to put in a new boiler, whether your tenants are going to move on and you might have dead periods where you have to pay the BTL mortgage payment from your sole income and whether you can get rid of your second property quickly enough to access your cash and be able to pay the DEBT on your family home when the payments on your family home become unaffordable. Plus whether its really worth the dead money in legal fees, search fees, land registry fees, estate agents fees, managing agents fees, capital gains tax, income tax, self assessment each year.....

If your circumstances were different BTL might be worth considering.

I think that having an interest only mortgage with no plan of how you are going to pay it off is asking for trouble.

There are several options open to the OP depending on her attitude to risk.

Does the OP mortgage allow any over payment even if she cannot pay off the entire lot? Most allow 10% without penalty.

"A £260k debt with no liquid assets and a low income could be very worrying."

The same could be said of a 160K debt. I imagine a btl producing £600 per month prehaps provideing £400 after expenses would pay of a sizable chunk over 20 years. If the asset itself appreciates then it will pay of the remainder of the balance. I imagine that rent will increase as well over the coming years.

OP how old are the DCs?

I imagine that rent will increase as well over the coming years.

Not necessarily. Rents can be quite volatile. The flat I rent out has been dropping in rental price for the last 8 years, which has a significant impact on its sale price to another landlord. Overall rents in the city where I live (not where the flat is) have not risen in years, not sure if they've dropped quite as much as I'm finding. My flat has become less attractive because of a number of factors outside my control (scaling back of personnel at the nearby airforce base, and the fact that rising house prices have pushed this small town in deepest Suffolk into the commuter zone for London, so a whole load of flats have been built much closer to the station). Add to that expenses like the landlord being liable for Council Tax when the property is empty and it doesn't take much at the lower end of the rental market for a property to be barely profitable.

That said, my property wasn't bought for investment and so it struggles more than a well-chosen property in the right area would.

I'm fairly sure anywhere within walking distance of any city centre will not go down in value because there is less likelihood of major change. The worst that can happen is that work completely dries up in that particular city, however I think most cities outside London will be doing better in future as London is becoming too expensive for businesses. Perhaps that's wishful thinking.

The good thing about investing the money as opposed to reducing your mortgage is that you can always sell / move the money if you need to. A rental income will cover your savings for the IO mortgage and give you a little extra. If you decide to move in the future you will have cash available to make that happen (if you sell the investment property).

There is a risk rent controls might be re introduced as we had decades ago or more taxes on lettings or a change in law not to let interest be set against rent although that's all pretty unlikely.

I don't agree that paying off the debt means no cash available. It is just as liquid as if you buy a buy to let except the value increase is tax free if the money is in your house and taxed at 28% if you sell a buy to let and make a gain. Also if you put it just into your house and suddenly need cash most people can remortgage or go for equity release if they really need to or indeed sell in hard times.

Should someone PM the OP. and tell her she is still receiving advice?

But Laura it's not as liquid if it's in your house really. Having a regular rent coming in is surely going to be more liquid. And what's the 28% tax you mentioned?

28% is the higher rate of Capital Gains Tax.

Yes but anyone making a normal sort of profit on a buy to let is going to pay 28% capital gains tax. You keep it 30 years and make £200k for most people all or most of that will be taxed at 28%.

Many buy to letters make no profit at all and just hope for capital returns. My daughter makes none on hers.

Anyway I think we've all given good advice on both sides so she can make up her mind.

Thanks Laura the penny has dropped. :)

I think it's a bit unfair to say that all financial advisors are just out for your money. I've just started working for an adviser and I'm pretty sure it's illegal for them to try and influence you purely for their own benefit. True they may benefit initially if someone invests, but certainly not in the long run if it turns out to be a bad decision made on their part and you have cause to complain - it would really bite them in the bum.. They have to jump through hundreds of regulatory hoops. I know - I have to process all the damn paper work!

Obviously not all are honest, but still.

I think I'd probably pay some mortgage off, anyway.

Wow! I didn't realise there had been so many more posts.

Thank you all so much for your advice; it's really helpful.

You've sold me on the idea of paying off a substantial chunk of the mortgage. I really like the idea of feeling that we owe much less, and also that we'll be unruffled by our interest payments as interest rates rise.

I would just like to say for the record that I fully appreciate that the mortgage is a debt, and a big one. We took it out at a time when we genuinely believed we weren't going to have difficulty paying it off. We don't have any other debts at all - it's just not the way we live. We're disciplined with money. We just find ourselves in an unforeseen situation where our circumstances have changed drastically since taking it on, and beyond the currently manageable interest payments, modest saving for repayment isn't proving adequate.

Very few of you seem to think investing is a good idea. I've buried myself in Excel doing some more in-depth calculations with respect to this, and I can see that the maths just doesn't add up. If I could achieve an average growth rate of 4% net over the 20 years (can't bank on that), and base rate were to go up gently, incrementally, to a maximum of 5%, I would save just £5,000 by investing instead of paying off a chunk now! It's not worth it. And I don't think I could hope for any more than 4% growth net; I think that would be good given the wider economic context.

I'm intrigued by the later posts suggesting helping the repayment process along with rental income. I don't want the responsibility of a buy-to-let, and I agree with littleredsquirrel about all the what ifs; I'd worry about these hanging over us.

However, something that has occurred to us, which combines the pay-a-chunk-off and sort-some-letting-income schools of thought, is to use a small amount of the cash to convert the garage, which we don't really need, to an additional bedroom suite. We could then let this to a lodger (there's quite a demand for lodgings round here) - maybe just Monday-Friday. The work would pay for itself within a few years, and after that, could help generate money to repay the mortgage.

This way, we'd be reducing the debt considerably in one hit as well as setting up something to help pay off the remainder.

Good idea? Is having a lodger too fraught with its own problems? Are most lenders happy with borrowers having a lodger?

Anyway, I need to get to bed, but again, thank you all so much for taking the time to offer your advice. It's prompted me to dig deeper into the figures and arrive at a solid decision.

Very grateful.

I think that is a really good plan. Rent a room scheme is tax efficient too!

Excellent idea to invest in your garage. It's a great solution. I know a very nice family with 3 young children who let out their loft to top up their income.

A Mon-Fri business lodger sounds a great idea to me. There is a generous tax allowance before rental income from a lodger becomes taxable, I think, and you can offset your expenses against it.

Do pay attention to the matter of ownership of your capital, though - £100,000 is a lot of money if you are joint tenants and you are gifting him half. Maybe he put in higher capital / mortgage when he was a high earner?

I think that sounds a good plan. I think with a lodger its a matter of finding the right person.

How big is your garage? If your lodger has his own sitting area, kitchenette, bathroom as well as bedroom it could work well. If your garage has just enough space for room then there would be risk of you been driven mad by your lodger.

Yes good idea. It might increase the value of the house. i agree with Sally about the issue over who owns the £100k, you or you and your spouse jointly once you make the repayment. you might want to protect it for the children by holding the house as tenants in common and your share being bigger than his as you put the £100k into it so that if you split he cannot claim half of it (assuming not married here and a partner instead).

Business lodger is a great idea - someone I know does it and she loves it - they get a reasonable income for very little work, once the initial outlay has taken place.

Just to be contrary I wouldn't do the lodger thing - just because you then have to have a lodger! Who might be noisy / smelly / awkward. If he had a bedroom suite then is that bedroom and bathroom? Ie would he be wanting to use your kitchen? To be exact would he be wanting to use your kitchen at breakfast time when you are racing round trying to get the kids out the door or tea time when you are trying to do the fun working mum thing of get in the house, get dinner cooked, get kids fed, get kids bathed get kids in bed all in about 90 minutes (or is that just my life?)

Bleurghhhh - no - couldn't face it!

Personally I would pay it all off the mortgage then but keep your payment the same and also add on the extra few hundred a month you have been saving and pay all that off the mortgage each month. It depends what "a few hundred" is and what happens to base rates in the future but some very quick back of an envelope calcs make me think that you would be able to get most of it paid off in 20 years by doing that. And it is the least risky option by a million miles!

Speaking as someone who spent the second half of her 20s obsessed with reducing her mortgage there is nothing better than knowing that your children's home is safe.

In some ways though the garage option is still in fact a buy to let, but you are building the property. It could also cost a lot of money if it includes a kitchenette and bathroom - they will need a loo. I guess it's still better than buying a second home as you don't have to pay 28% CGT when you sell.

" I guess it's still better than buying a second home as you don't have to pay 28% CGT when you sell."

There will be less captial gain as well.

Still the main thingi is that the OP has a plan that she is happy with. I think that this thread shows that we all have a different attitude and perception of risk.

If the OP has a double garage then it would take around 20k to convert it into an annexe. She might also have asbestos removal as prior to 1990s garage ceilings had to be made of asbestos. IF asbestos removal is needed then it would add to the cost.

I think its essential that the lodger has his own front door. I suppose it would be like a studio flat. I think the OP would have to look at the rules to make she doesn't create a seperate dwelling by accident.

webarchive.nationalarchives.gov.uk/20110412204337/http:/www.voa.gov.uk/publications/public_fact_sheets/self-contained-units-factsheet.pdf

To avoid the garage as being classified as a seperate dwelling the lodger would need to share some facilites. (for example if you both had access to the downstairs bathroom, even if in practice you agree not to use it.

OP
Pay off as much of the Mortgage as you can.
Keep your repayments the same so that you are actually paying down the capital sum even quicker
and yes, yes to rent a room

I just bumped my mortgage calculator sheet to the top of the board so you can see the impact of regular overpayments