Pay off Mortgage?

[Mortgagewonder]

I am just wondering if paying off our mortgage very early is the right thing to do? Due to a windfall from insurance my wife and I have the capacity to pay off our mortgage now. We are both mid 30s with two kids and no immediate plans to move house. Household income is approx 65k and remaining mortgage is about 170k. The money is in a high interest account just now as our financial advisor warned us against paying off our mortgage. We are noticing the tax burden of the interest as we are both currently PAYE and not used to dealing with HMRC.
We did set some money aside to pay down the mortgage until our fixed rate ends and we aren’t squandering the money either. I have massively upped my pension contributions and we have stocks and shares ISAs but we are living more comfortably than ever before.

What penalty will you pay if you pay it off early? What interest rate do you currently have on the mortgage?

To pay off now it’s about 0.5% of the balance as a penalty so quite a chunk. We fixed when things were at the lowest so paying 1.14% until 2027.
I was more thinking of talking to our lender so that we maybe didn’t pay it all off right away to avoid the fee. The tax on the interest we are getting is the main issue.

There is a calculation to be done to work out whether the penalty is more of less than the interest you would pay on the mortgage for the next two years. If the penalty costs more, then it isn't worth paying it off.

I was in a very similar position a long time ago and found that with an overdraft (off-set) type mortgage simply using the 'windfall' to offset the mortgage was a useful approach until I decided what to do in the long run: the monthly payments went straight to reducing the capital, and because the windfall wasn't earning any interest then there were no tax implications. And of course the windfall was still there, available, for when I decided what to do with it. My mortgage was with First Direct at the time and they have unfortunately withdrawn from the off-set mortgage market, but it might be worth exploring this with other lenders as a short or medium term option.

What reasons did your financial advisor give for not paying off the mortgage?

Realistically, if you invest the windfall in the stock market then over the long term you'll probably obtain a greater return than using it to pay off the mortgage, but I guess it really depends on your risk appetite and what you'd do with the money if not pay off the mortgage, as well as how manageable your repayments are at the moment.

Household income is relatively low. I’d be looking to put the max into pensions and S&S ISAs for this tax year and have the same lined up for a few future ones as well. So could put in fixed rate bonds for 1,2 and 3 years for example.

did the advisor explain why paying off mortgage isn’t a good plan? As above it’s generally due to early payment fees and interest rate. But also because it makes you pay it monthly rather than just squander that money away if you see what I mean. Even if you think you’ll keep that amount of your income seperate for savings it’s psychologically much easier to think ‘oh it’s been an exceptional month so I won’t save as much this month’. And that concaternates over a 10 year period to a substantial difference.

If it's the interest that's the issue, could you move it into ISAs or Premium Bonds or other NSI products that avoid income tax on interest?

At that low an interest rate I would wait until the fix runs out in 2027 before paying it off, you will be making more than that in a high interest account. You can each put £20,000 into an ISA this year if you haven't already which will take interest on £40,000 out of tax, and the same next tax year if they don't change anything in the meantime.

Gift some money to your children for potential uni fees? If you decide not to pay off the mortgage and put into ISAs.

Hopefully you've both maxed out ISAs and premium bonds, so £140k which is tax free?

Thanks but With the ISA limit of 20k and we have around 160k sitting just now that’s not really viable. Not sure about the premium bond option either.

Thanks but our main issue is the tax, so it’s about £7000 a year interest that we are paying tax on

Have you maxed out the kids' ISAs and pensions allowances? That takes a further £23760 out of HMRC's reach each tax year.

I’d say household income is average for the north of England especially considering OH only works part time.
The advisor was pushing us towards investing the windfall money long term but carrying on to pay the mortgage as is.
As I explained we aren’t the type to squander the money, we have no other debt or even finance for cars or similar. Currently putting around £900 a month into stocks and shares ISAs and sitting on the excess.

Is the interest you've earnt after tax not still more than the mortgage interest (+ potential penalty), though? If so, you're still better off, which is presumably why your financial advisor said not to pay off the mortgage.

Decided against ISAs in the kids names after realising the money goes directly to the kids at 18 and that’s a whole other can of worms.

Don't put £900 a month into ISA. Max them out right now.

If you invest the money, it needs to be for the longer term as you might see fluctuations down as well as up shorter term. However, you can avoid paying any tax as you don't pay tax on returns from investments until you 'realise' them, i.e. sell the stock and actually get the profit. You can each move £20k of your holdings per year into a S&S ISA, so eventually all the money ends up in the ISA without you having actually sold the shares.

Thanks but the bulk of the money is currently in a fixed rate bond

You could have put 20k each in prior to the financial year ended, and another 40k for this financial year, then 50k each to premium bonds for you and children - it all remains in easy each and is tax free. We have the full holding each and out any winnings into the kids' bonds

Just to clarify since we aren’t the type for any debts we are swaying towards it would be nice to get the millstone of a mortgage gone while we are so young.

We were in a similar position 2.5 years ago - inherited a substantial sum following the death of MIL (enough to pay off our mortgage and have a decent lump sum spare). As our mortgage was on a rate of 1.4% fixed until September 2025 (with a penalty if we paid off early), we decided to invest the money across a variety of platforms - maxed out ISAs, invested in NS&I Fixed Rate Bonds (which were offering the best rate on the market at the time, they may not be now), invested in Premium Bonds and opened a couple of higher rate cash savings accounts so that we had access to money if we needed it.

Turns out we did need that cash access as DH ended up unemployed for 8 months last year!

We're now in a position with the various Bonds, etc due to mature later this summer and we are going to pay off our mortgage. We plan to pay the money that was paying our monthly mortgage instalments straight into a stocks and shares GIA so that it is still working for us and we don't get into the habit of frittering it away.

Depending on the maths you might want to wait until 2027 - but I would personally pay the mortgage at the 2027 milestone at the latest.

Whilst theoretically you can make more money by keeping the mortgage, my mindset is that dropping such a big expense gives you more security in case of illness, job loss etc.

As others have said, it really depends on your attitude to risk - I suspect yours is fairly similar to mine.

I would over pay mortgage until deal ends, max premium bonds and AISA’s

If that is your preference then you should do it. However, at that low rate of interest you will still be better off with a decent rate of interest even after tax.
Maybe earn the interest and then pay the mortgage off when the fixed rate expires as you will not get that again.
Make sure you keep a decent sized emergency fund.

You are still earning more in interest even after paying the tax on it though.

Keep in mind that the financial advisor almost certainly makes a commission if you invest something, and makes no commission if you pay off your mortgage. You need to tread the advice of financial advisors VERY carefully for this reason. Ask what commission he will make on each and every product he suggests.

Personally, given that Trump may well be about to plunge us into a global recession, I wouldn’t be putting my money into anything where it is tied to the markets, except pension which is tax effective and which you won’t cash in for many many years. I’d do as others here suggest - max out ISAs and pension contributions, then pay off your mortgage once the fixed rate expires and you can do so without penalty. As for the tax you pay on interest in the meantime, think of it as your extra contribution to the NHS, schools, roads, etc.