I have just taken early retirement due to ill health and received a tax free lump sum and regular pension income. My wife is self employed and I intend to help her a little with her business. We have a mortgage and I wonder if we should consider paying it off with some of my lump some? I also wonder what we should do with the investment-linked endowment we took out with our mortgage?
I am a great fan of paying off debt. Debt is a drag and can prevent you from doing the things you want to do.
By paying off your mortgage, more of your monthly income will be available for you to do as you wish. However, there are advantages and disadvantages.
One way to look at it is to ask yourself how much interest you pay on the outstanding mortgage and how much interest you get on the cash you have. It is likely that your mortgage interest (paid out of taxed income) is greater than the interest you receive from your savings (which is subject to income tax).
To get a greater return on your capital, you may well have to take on board two things – risk and volatility. The risk is that you may end up with less capital than you invested.
Volatility means that the value of your investment can go up and down over time.
Writing out a cheque to pay off the mortgage is a form of investment. You move the money away from getting interest and invest it in the bricks and mortar of your house.
The future value of property can go down as well as up but most people retain a high degree of confidence in the long-term value of property.
When you crunch the numbers, you will probably conclude that paying off the mortgage will save you a lot of future interest payments. On a more subjective note, many people are reluctant to use their hard-earned capital to pay off debt.
Don’t be shy about this. There is, I can tell you, a rather wonderful non-financially quantifiable benefit in paying off a mortgage. Your home will belong to you and you will never have the worry of keeping up the payments.
Keep some of your capital as an emergency fund, just in case. In the future, if and when the Bank of England raises interest rates, instead on bemoaning the fact that your mortgage payments have gone up, you will be able to have a self-satisfied glow of knowing that your savings are paying you more.
You mention that your wife is self-employed and this may mean that your household has variable earnings. You at least now have the certainty of income that your pension brings. By reducing your monthly outgoings by paying off the mortgage, this might also mean reduced financial pressure each month.
You have two choices in respect of your investment-linked endowment. You can keep it going to maturity and carry on paying the premiums.
The maturity value is unknown because it will depend on future investment conditions along with the performance of the provider and the selected investment funds. Alternatively, you might surrender the policy now and enjoy the proceeds as well as saving the cost of future premiums.
As you have retired early due to ill-health, you need to recognise that if you surrender the endowment policy, you will lose the associated life insurance cover and you must consider the impact of that on your family if you were to die.
Your decision may well be based on your attitude towards investment risk and reward and what expectations you have of future investment returns.
In respect of your mortgage and your endowment policy, check the cost of redemption and surrender. There should not be expensive barriers to prevent you from redeeming your mortgage although you may have to pay a fee to the lender. For the endowment policy, there may well be quite severe surrender penalties.
Overall, however, the certainty of paying off the mortgage and saving future costs may be quite compelling.
Nick Bamford is managing director of Informed Choice