I have taken a lump sum pension: do I have to pay off my mortgage of € 117,000?

I bought a buy-to-let in 2007 with a 25 year mortgage, which now has just over seven years remaining.

The mortgage balance is now €117,000. Currently it has a variable interest rate, but I am considering committing to this for two years with the same bank to lower my monthly payments as I think the interest rate will slowly decrease.

But I recently retired and took a lump sum out of my pension. I am considering selling the house in 2032 near the end of the mortgage.

Instead of taking out a new mortgage, should I consider using part of the lump sum now to pay off the property?

The alternative is to keep the buyout amount and pay off the mortgage through the sale of the property in seven years, when the mortgage term expires.

If I did that, would I pay less capital gains tax because I would be paying back some of the value of the property to the mortgage lender and not benefiting from it myself?

Ed Magnus from This is Money answers: Even though you may have just purchased this property before the 2008 housing crisis, hopefully your rental property has proven to be a good investment in the long run.

The property has a significant interest-only mortgage, which you say has a variable interest rate.

Although current forecasts suggest the Bank of England will cut interest rates from 4.75 percent to 4 percent or 3.75 percent by the end of this year, there is no guarantee this will happen.

Predictions are often wrong. At the beginning of 2024, markets were predicting that the central bank would cut rates six times over the course of the year. In the end there were only two, while the interest rate fell from 5.25 percent to 4.75 percent.

According to Moneyfacts, the average two-year fixation on a buy-to-let mortgage is currently 5.34 percent. On a £117,000 interest-only mortgage that would equate to £520 per month.

Depending on your situation, the type of home and the amount of equity you have in the home, you may be able to do much better than the average rate.

The cheapest two-year fixed-rate mortgages from some major banks are under 5 percent.

For example, Virgin Money charges £4.54 for a two-year fix with a 1 per cent settlement fee. On your £117,000 mortgage, that would mean paying £443 a month interest-only.

It’s worth speaking to a mortgage advisor to assess your options.

Paying off part of the mortgage early with a pension amount can be a good idea if you want to reduce your finances.

However, your capital gains tax liability does not change whether you pay off the mortgage through a lump sum or through the sale of the property.

We spoke to for expert advice Karen Nojemortgage expert at Quilter and Elena Todorovadirector of mortgage broker SPF Private Clients.

What are the capital gains tax rules?

Elena Todorova replies: Surprisingly, the amount of capital gains tax is not linked to the amount of debt you have on the property.

Capital gains are roughly calculated by deducting the purchase price from the sale price, as well as any costs such as stamp duty, estate agents’ fees, legal fees and the cost of structural improvements.

It does not matter whether you have a mortgage that you have to repay when you sell.

His Majesty’s Tax Authorities are interested in the increase in the value of the property and not in the question of whether there are any obligations attached to it.

You also can’t deduct the money you spend on routine repairs and maintenance of the property.

Do they have to pay the mortgage with their pension amount?

Karen Noye answers: If you use your pension amount to pay off all or part of the mortgage, this will not directly affect the calculation of the CGT.

You are right that the predictions are that interest rates are likely to fall relatively slowly.

However, this is just a prediction, so making a decision based on your current finances is the best course of action.

Don’t forget that since 2020, landlords can no longer deduct mortgage interest from rental income.

Instead, you will receive a 20 percent tax credit on your mortgage interest, which could have consequences for your finances.

Using your pension to reduce your mortgage can help reduce your monthly costs, but it’s crucial to consider how this could impact your retirement plans and quality of life as you get older.

Elena Todorova adds: If you use your lump sum to reduce the loan, this will affect any tax credit you can claim in your tax return.

Technically, the smaller the loan, the lower the tax credit and the higher the taxes you would pay on the rental income.

You also need to consider the opportunity cost. Would it be better to leave the funds in your pension where they can grow in a tax-efficient environment and generate higher pension returns?

Or reduce your pension, giving you a lower monthly income while still saving a certain amount on interest?

Withdrawing pension funds has consequences for your pension in the longer term. If you pay off now, the mortgage you pay will be immediately reduced.

Before you make a final decision, I recommend that you first talk to a tax advisor, financial advisor and of course a mortgage advisor.

Should they fix their variable mortgage interest rate?

Karen Noye answers: If you decide to keep the mortgage and not pay it off, switching to a fixed rate could give you more predictable payments and save money in the short term.

If you were to take a two-year fix, you would have the opportunity to reassess when rates could be lower.