House Doctor: 'How can I use my inheritance to pay down my mortgage debt?'

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The Independent Online

Question: My father died recently and I've come into £90,000. I want to use it all to pay down a large chunk of my mortgage, but should I use it in one go to reduce my monthly £1,800 payment on my roughly £240,000 mortgage, an RBS two-year fix at 3.4 per cent? Or should I drip-feed it, or shorten the 14-year term?"

Mrs Sonia Nickerson, Swindon

Answer: Whether you use the cash to reduce your monthly outgoings or keep it the same and clear your mortgage more quickly, shrinking your loan size means you'll pay less interest over its life. But be careful.

Making a one-off £90,000 lump-sum overpayment is a financial no-no, David Hollingworth at broker London & Country warns: "Penalties for early repayment of such a large sum will typically apply during a fixed-rate period and can be 3 per cent, or more, of the amount repaid, so costing you at least £2,700."

Most lenders, though, allow some overpayment "flexibility", typically letting you pay down 10 per cent of your outstanding mortgage balance each year without a penalty.

Dig out your most recent mortgage statement – or your original mortgage documents – to see what scope you have. If, as should be the case, you can repay up to 10 per cent each year without charge, then a series of smaller lump sums will be the best way to start cutting your mortgage immediately.

Melanie Bien at the broker Private Finance calculates that if you pay off £24,000 of the mortgage now, "your monthly payments would tumble from £1,797 per month to £1,618". Lop another 10 per cent off in 2012 and they'd drop to £1,524, she adds.

But this approach has a drawback, Hollingworth warns: "If you should need a sizeable lump sum for an emergency, say, [your funds] are very hard to tap back into once used to pay down home-loan debt."

If this is a worry, shrinking the length of your mortgage term might be more appealing, he adds: "Cutting your mortgage term would give a monthly payment of £2,126." This way, your £90,000 would cover the extra monthly cost while still offering you "cash on tap" in an emergency.

You might also consider an "offset" deal at the end of the fixed term: by handing over your cash to your lender, you could cut the interest bill (and pay no tax on the cash) but still retain easy access to the funds if you need them.

housedoctor@independent.co.uk

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