Big ideas for losing interest

Gordon and Alyx want to know whether it is a good idea to use their savings to pay off their mortgage. Gordon writes:

'We are both 33, married for five years with two children - aged two and eight months - with no plans to have any more. I gave up full-time work to become a house-husband two years ago and I do not plan to return until the children go to school. In the meantime, I work as a part-time supply teacher. Alyx is a chartered accountant and her income is £43,000, but would like to reduce her hours.

We want to pay off our mortgage as quickly as possible, say within 10 years. To achieve this we plan to use our savings to reduce the mortgage capital each time we remortgage and then save to reduce the capital again.

'We have a £122,000 interest-only mortgage with the Nationwide, fixed at 3.89 per cent until May 2005, which costs us £405 per month. We have two endowment policies with the Prudential for £72,000 and £78,000, which are due to mature in 2023. Both are currently on target.

Our savings consist of £25,000 invested in a variety of unit trust Isas to which we contribute £400 per month, £6,000 in mini cash Isas, and £18,000 (largely from a recent inheritance) in a Cahoot savings account in which we also save a further £300 to £400 each month.

Should we use all £49,000 of our savings to reduce the capital outstanding and get another two-year fixed-rate in May; or reduce the capital by the cash savings of £24,000 and leave the Isas to grow, hopefully, at a higher rate than the mortgage charge; or get an offset mortgage (interest only) such as the One Account and put all the savings into the account and reduce the interest accordingly?

In all cases we will leave the endowments to mature into a lump sum for the children in their 20s. We also save £25 per month for each child into a building society savings account and have money in a National Savings Children's Bonus Bond. Is this the best place for our children's money?'

Fear not - there are plenty of options:

You have managed your money very well and are in a strong financial position with plenty of choices. When it comes to repaying a mortgage with savings there is not a right or a wrong answer and much depends on your priorities and expectations.

First you should consider how much of your savings you want to keep accessible and what rates of return you can expect on your savings. It is advisable to keep a contingency fund - your mini cash Isas could fit this bill.

Ray Boulger, senior technical manager at Charcol, the mortgage adviser, says : 'Gordon and Alyx should keep their mini cash Isas as the top accounts pay a tax-free interest rate higher than the rate they would pay on a competitive mortgage.'

The decision on whether you should retain your existing unit trust Isas or cash them in to reduce the mortgage depends on your attitude to risk and the likely performance of the stock market.

Boulger explains: 'On the assumption that Gordon and Alyx are comfortable with some risk, if they expect the combination of dividends and capital growth on their Isas to exceed the interest rate on their mortgage in the next few years they should keep the Isas.'

Donna Bradshaw, of independent financial advisers IFG Financial Services, agrees you should keep your stocks and shares Isas. 'They are long-term investments and will help toward funding for a comfortable retirement or as additional funds to help pay for their children's education. If they were cashed in now, it would convert what are currently paper losses into actual losses. Gordon and Alyx do, however, need to review their Isa portfolio to ensure the current asset mix meets their investment objectives.'

Bradshaw believes your portfolio is very speculative and particularly overweight in technology and healthcare funds - leaving you exposed to very high levels of risk. She suggests rebalancing your portfolio towards more moderate risk UK income and growth funds, either by switching funds or re-channelling your regular savings.

Regarding your mortgage, Boulger believes your current lender Nationwide has a good all-round mortgage proposition. 'Although their rates are not market-leading, some of them, in particular the five-year fixed-rate of 4.95 per cent, are competitive and are available to existing customers. In addition all their mortgages allow overpayments of up to £500 per month without any early repayment charge.'

While you could have ultimate flexibility with an offset mortgage, if Nationwide's proposition offers you adequate flexibility it is well worth considering as the interest rate is a little lower than on a fixed-rate offset mortgage and it will avoid changing lenders.

Boulger says a simple option would be for you to stay with Nationwide when your current fixed rate finishes in May and use your £18,000 Cahoot savings to reduce the balance on your mortgage before switching to another deal. You could then change the mortgage from interest-only to repayment as you can easily afford to pay more each month and want to pay the mortgage off as quickly as possible. The repayment term could be changed if necessary and could be calculated on the basis of what monthly payment you are happy to commit to. You could then over pay up to £500 per month, without penalty, in the knowledge that if you needed any of these overpayments you could stop making them. Any overpayments will immediately reduce the balance of the mortgage.

This will create a virtuous circle because, as the balance outstanding on your mortgage falls each month, less will be needed to pay the interest and thus a progressively increasing amount will be used to reduce the capital. This will be a significant help towards your intention of repaying your mortgage within 10 years. Nationwide offers fixed rates at the same level of 4.95 per cent for two, three or five years.

If you are looking for greater access to your savings an offset mortgage would be a better option. Boulger says only three lenders currently offer offset mortgages with fixed rates for at least three years. The most competitive are Yorkshire Building Society and Clydesdale Bank.

As your children are so young, it may be worth considering a stock market investment for their savings. Equities still outperform cash in the longer run.

Gordon and Alyx's to-do list:

1. Decide how much of your savings you would like to have access to.

2. Keep your mini cash Isas intact.

3. Keep stocks and shares Isas as long-term investments but look at making your portfolio less high-risk.

4. Use your Cahoot savings to reduce your mortage. Consider a longer-term fixed-rate with Nationwide.

5. Switch to a capital repayment mortgage and make regular overpayments to pay off your mortgage quicker.

6. Consider investment trust savings plans for your children.

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