Money magic: What to do with spare cash

Low interest rates mean anyone on a variable mortgage rate is quids in. But what to do with the money? Paul Lewis has some options

What shall I do with all this spare cash? It is an unusual question. But one that more and more people are asking when their fixed rate mortgage comes to an end. Instead of rushing round to find a new deal many people are now happily paying the standard variable rate – perhaps 2% or lower – on their home loan. And then wondering what to do with the money they save each month. I can identify four options:

Option 1

Spend it. That is what the government would like us to do. It is already pumping billions into the economy and if we do our bit by spending more the recession may end more quickly. That may be good for the country – and fun – but it is not a sensible use of the windfall. But given the kind of summer we’ve had, many will have used the excuse of a low rate to take a foreign holiday, and who can blame them?

Option 2

Pay down the mortgage debt. The easiest way to do that is to keep your monthly payments the same – after all if you could manage it last month you can afford it next. That way your total debt is reduced and you will be mortgage-free years earlier. But with home loans for existing borrowers now so cheap, a home loan is good value. So there may be better ways to use it.

Option 3

This is one for most of us – pay off your other debts. The best use of the money then is to pay down the most expensive one. That will almost certainly be a credit card. The average rate has been creeping up – despite falling interest rates – and is now more than 18%. A typical £2,000 debt on a card charging 18.9% will cost you nearly £380 a year in interest alone. Paying that off over a year will make you £7 a week better off forever.

Option 4

This is for those lucky folk who have no debts apart from the mortgage.

Instead of paying down the home loan they may make more money by putting the spare cash into a high interest cash ISA. You can get just under 3% tax free on an instant access ISA or just over 3% on a one-year bond ISA.

If that is more than the rate on the mortgage it makes sense to save. And when the balance shifts the other way use the savings – plus interest – to pay a lump sum off the debt.

Always watch for restrictions on savings accounts and penalties when you pay off a mortgage or other debt. But with care any spare cash can do money magic.

Paul Lewis is a freelance writer. He presents Money Box on BBC Radio 4

This article is published in the 17 September 2009 edition of Community Care under the headline “What to do with all your money”