I’ve received a generous lump sum of cash – should I save it or use it to pay down my mortgage?

I’ve recently received a generous lump sum of cash and I’m at a loss for what to do with it.

Aside from a family holiday and a few very minor home improvements, I have no real use for the rest of it, so what’s the best way to make it work for me? 

I’d like to pay down my mortgage as much as possible but I can only overpay by 10 per cent.

Should I invest the remainder of the cash or is there any way to feed more into my home’s equity?     

David Hollingworth, of L&C Mortgages, replies: Although savings rates have been on the increase recently they are still low in historical terms.  

It’s always important to have a rainy day fund available of course, so that there’s cash that’s easily accessible in case of an unforeseen circumstance, such as the boiler packing up or the need for urgent repair to a leaky roof.

As an alternative to saving there’s a strong case for considering reducing debt when deciding how to employ a lump sum of cash. 

As debt is likely to carry a higher interest rate than is available on savings rates, it makes sense to consider whether paying off debts is a possibility to give a better return on the cash than putting it on deposit.

If paying off debt is a strategy you want to pursue then look at your outstanding debts in order of interest rate, starting with those carrying the highest rates. 

What about mortgage debt? 

Mortgage rates are likely to be more competitive than those available on debts such as personal loans and credit cards but if there’s no more expensive outstanding debt elsewhere overpaying the mortgage could be the place to start.

Overpaying by even small amounts each month can make a big difference to the total interest paid on a mortgage over its life. 

However, in this case it sounds like there is a bigger lump sum to play with rather than regular monthly amounts.

Before making any overpayment, large or small, it’s vital that you understand the terms of the mortgage deal. 

If you are within a fixed, discounted or tracking rate period the product may tie you in with early repayment changes. 

These are often charged as a percentage of the overpayment, typically around 3-5 per cent but can be higher or lower. They can therefore be substantial amounts where chargeable and could easily eliminate the benefit of overpaying altogether.

Thankfully most lenders recognise that borrowers want more flexibility and the majority will now allow borrowers to make a partial overpayment without incurring an early repayment charge. 

The majority of lenders will typically limit overpayments to 10 per cent of the outstanding mortgage balance each year but that can vary by lender and potentially by the deal itself so it’s important to check the detail.

Some lenders will offer penalty free overpayments of up to 20 per cent per annum whilst others can impose monthly amounts of say £1,000 a month. 

Offset mortgages offer an alternative option where lump sums can be held in a separate savings account but reduce the interest charged on the mortgage rather than earn interest.

If you are limited to what sounds like 10 per cent of the monthly payment each month then it’s likely to be counterproductive to breach that limit. 

Check your original offer or with your lender to get the specific details of what the charge will be and if there is an annual allowance that could give more flexibility for a lump sum overpayment. 

It could also be useful to understand whether there is a reduction in the early repayment charge and when, as well as whether any limit is within the calendar year or the anniversary of taking the original mortgage. 

Otherwise it may pay to save the funds elsewhere for now and drip feed them into regular overpayments, before making a bigger reduction when your deal comes to an end and you can review the overall mortgage.