Overpaying / clearing mortgage before moving?

Divers

We've got a house worth roughly £200k, with an outstanding mortgage around £90k. Our medium-to-long term plan has been to move to a 'forever home', which in the location and size we want, would be around £500k. (We can get a mortgage of £300k, we just went conservative for this house, which was our first.)

We may be about to receive a windfall of about £100k. My initial plan was to just put that in savings, then when we think we're ready to start moving, we've got that plus the existing equity in our home to use to meet the requirements we have. It would just bring forward our move by a few years.

Then I started wondering if this would be a good case for actually overpaying or even clearing the current mortgage. It's fixed at 2.09% until early 2022. So what are the downsides? I can think of:

1. We have less liquidity now than we would otherwise. (We do have sufficient emergency savings, plus regular investments and pension contributions, so we're not really hurting for cash.)
2. The early repayment charge means that clearing it might not make sense from a strictly financial perspective, although there's some psychological benefit.
3. On the psychological side, it might feel strange to go from mortgage-free to a much bigger mortgage than we had before.

But I feel like I'm missing something. I know there's no right or wrong answer here, but I'm curious about what people think.

DiggerUK

First things first. I am in the clear your mortgage first school, it's a fixed, secure, no risk asset when you do so. 

Mortgage is a debt, you got no choice but to pay it off some day, why fanny around.......check current t's & c's about penalties for early payment, put the balance in PB's If you have to wait. 

As your cash flow will increase the savings can be put towards a bigger deposit when you eventually upsize, as well as being  a handy pot to dip in to for the here and now.
Best of fortune..._

couth

Nice problem to have. I would overpay to the max so that you don't incur ERC, but not clear it altogether, then revisit in 2022 when your fixed rate ends. Many things can happen until then... On your last point, a £90K mortgage is not that high anyway, and it will be lower by 2022 even if you don't overpay... so tripling or quadrupling your mortgage will have a similar impact :-) 

steampowered

The downside of clearing a mortgage early is "opportunity cost". You could be using that money in a way which is more productive for your long term wealth and wellbeing.

Financially, it makes very little sense to rush to clear a mortgage you can comfortably afford in an era when interest rates are at record lows. Government fiscal policy is extremely loose right now, which pushes down interest rates but inflates the prices of assets such as houses or stocks & shares. 

What does your investment situation look like? If you have not opened a stocks & shares ISA, now would be a good time to do that. You can start making the most of your allowance to invest up to £20k each year into a stocks & shares ISA. The average return generated by the major stock markets is about 7-8% per year. If you invest through an ISA that will be completely tax free - no capital gains tax or income tax. Meaning that a stock market tracker fund is extremely attractive when compared to the 2.09% interest you are paying on the mortgage.

What does your pension situation look like? Pensions are very attractive because you get tax relief. If you are a higher rate taxpayer, that £100k you have inherited could be turned into £140k in your pension due to the 40% tax relief. Having enough money to live on in retirement is just as important as clearing the mortgage. Using some of this money to top up your pension could be a very wise move.

However, if you need all of this windfall to move into your new home, you should keep it in savings rather than investing it, as investing and pensions are designed for the long term.

Albermarle

Plus of course you can do a bit of everything . Pay off some of the mortgage , invest some ( pension;S&S ISA) and keep some as savings . No need to see it as a black and white situation.

Divers

Thanks for the feedback, some useful thoughts there.

steampowered - I hinted at it above but wasn’t explicit. Our pension position is solid and our contributions are at a level I’m happy with (35% of my salary is into my DC pension through salary sacrifice, for instance). I also have an S&S ISA which, again, I’m happy with the current level and contribution rate. Your last paragraph hit the nail on the head.

couth - absolutely right, it is very much a nice problem to have. I think we’ll probably go with something along the lines of your suggestion, especially for your last point - it’ll be a much bigger number in the new mortgage no matter what we do!

phillw

steampowered said:

The downside of clearing a mortgage early is "opportunity cost". You could be using that money in a way which is more productive for your long term wealth and wellbeing.

It comes down to risk profile, mortgages are a dead cert but investments are not.
If you can still get a regular saver with higher interest rate than the mortgage then I'd throw some money in there, you can usually get the money back (with a loss of interest) in case of emergencies.
I'd then throw as much money to the mortgage as possible (without going over the ERC limit).
There is a mental health benefit of reducing your mortgage (although if you're planning on borrowing more again then that will be short lived).
From the looks of it you're going to have more money left over than most lenders allow (I was lucky and ended up with a mortgage with no ERC which allowed me to clear it as soon as I wanted), so you will need to figure out what to do with it in any event.