The world of investing can be confusing for a beginner. So when you receive a lump sum of money, it can be difficult to know which direction to take. Should you pay off your mortgage or invest?
To help break it down for you, we take a look at the pros and cons of paying off your mortgage, as well as when it makes sense to invest a lump sum instead.
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What should you look at first?
Before we take a look at whether paying off your mortgage or investing could be a good idea, there are a few financial questions you need to ask yourself first. The state your finances are in will largely dictate the best course of action for any extra cash you have.
Do you have emergency savings?
Having an emergency fund is important. The general rule of thumb is to have around three to six months’ salary in an easy access savings account in order to cover a job loss or unexpected expenses.
Do you have any expensive debts?
If you have an outstanding credit card balance, overdraft or a loan, then it could make sense to clear these first before committing your money to anything else.
These types of debt typically charge a higher rate of interest than you are paying on your mortgage or the return you could get on an investment. So clearing these first is a wise move.
Are you paying into a pension?
Your long-term financial health is important. The earlier you start to make contributions, the better the chance you have of building up a good pension pot. Also, pensions get tax relief from the government, so they are a very efficient way to save.
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Should I pay off my mortgage?
If you’ve got some spare cash, either a lump sum or some regular extra cash in your monthly budget, then you are probably wanting to do something meaningful with it.
Your mortgage is probably one of the biggest financial commitments you have. It is worth exploring whether it is a good idea to pay off your mortgage early.
There are pros and cons to doing this. As usual, it’s very much dependent on your personal circumstances and who your mortgage provider is.
The main benefit of paying off part of your mortgage is that you reduce the level of debt you owe and pay it off that much faster.
You also don’t pay interest on the amount you overpay, and as you have reduced your balance, you reduce your overall interest charges. Finally, the money you save on interest could beat what interest you could earn on savings.
However, one of the first things you will need to explore is whether your mortgage has any overpayment charges. Lenders typically say you can overpay by 10% a year. But this isn’t universal, so it is worth checking. Iif you get this wrong you could be required to pay thousands in fees.
Another downside if you are looking to pay off your mortgage is that you will lose access to that cash. If you are confident you have a sufficient emergency fund, this isn’t an issue. But if you think you may need to access that money at some point, you won’t want it tied up in your property.
Should I invest?
With interest rates being so low, you may well be thinking that investing would make more of an impact.
The main thing to bear in mind with investing is that returns are only expected, not guaranteed.
If you expect to invest for a long period of time, there is potential for growth. And it could well be that you could earn returns greater than the interest you would have to pay on your mortgage. But this is in no way certain.
It is important to keep in mind that it’s probably not a good idea to invest if it puts you at risk of not being able to pay your debts.
Sometimes, talking to a financial adviser can help you make sense of a situation. Unbiased.co.uk is an online directory that partners you with a financial adviser in your local area. If you want to learn more, check out our review of their services.
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