I’m seeking advice on how best to allocate a recent one-time bonus of £7,500 that I received from work.
There are three potential avenues I’m considering for this money.
Option 1: I could use the funds to make extra payments on a £12,000 bank loan, which I took out to buy a car. The loan carries a monthly payment of £395 with a 12.9% interest rate, and there’s no penalty for making additional payments.
Option 2: Another possibility is to overpay on my mortgage without incurring any extra fees on the £7,500. I still owe £97,000 on the mortgage, with 19 years left to pay it off. My monthly mortgage payment is £610 at an interest rate of 4.1%, and I will need to remortgage in 18 months.
Option 3: Alternatively, I could invest the £7,500 into my stocks and shares ISA, where I’m currently heavily invested in the S&P 500 and have a balance of £60,000.
Bonus dilemma: What is the best way to wisely spend my £7,500 windfall
Tanya Jefferies from This is Money responds: Congratulations on your work bonus. It’s commendable that you’re focused on leveraging it to strengthen your long-term financial stability.
But since it was no doubt earned for good work, I hope you will spend some modest sum on treating yourself as a reward.
When it comes to the sensible options you have outlined, we asked an experienced money expert for his take on your dilemma.
He has a definite recommendation on what you should prioritise.
Ray Black, chartered financial planner at Money Minder Financial Services, replies: When deciding what to do with a one-off bonus like £7,500, it helps to step back and think about three broad financial priorities – clearing expensive debt, securing your home, and building long-term investments.
Looking at the options you’ve outlined, the first thing that stands out is the bank loan at 12.9 per cent interest.
That is quite a high borrowing cost in today’s environment, and paying this down early would deliver a guaranteed return equivalent to the interest rate you are avoiding.
In simple terms, overpaying the loan is effectively the same as earning 12.9 per cent after tax with no investment risk.
Returns like that are very difficult to achieve elsewhere with certainty.
In your case the outstanding balance is £12,000.
Putting the £7,500 bonus towards the loan would significantly reduce what you owe and shorten the repayment period, meaning less interest paid overall.
One thing many people underestimate is just how expensive high interest borrowing can be over time.
Because loan repayments are spread over several years, it is easy to focus on the monthly payment rather than the total interest cost.
Reducing the balance early can make a surprisingly large difference to the overall amount repaid.
The mortgage option is different. With a rate of 4.1 per cent and 19 years remaining, the cost of that borrowing is much lower than the loan.
Making an overpayment would still reduce the long-term interest bill and could shorten the mortgage term, but financially the benefit is smaller compared with clearing the higher interest debt first.
Mortgage overpayments can still make sense for some people, particularly if they value the peace of mind of reducing their mortgage balance or want to become mortgage-free sooner.
However, when comparing the numbers alone, the loan interest rate is the more pressing issue.
The third option is investing the money in your stocks and shares Isa.
As you already have around £60,000 invested and are heavily weighted towards the S&P 500, your portfolio is strongly linked to the performance of large US companies.
Over the long term, stock markets have historically produced returns higher than mortgage rates, but those returns are not guaranteed and markets can fluctuate significantly in the short term.
If most of your investments are concentrated in one market, such as the US, it may also be worth thinking about diversification over time so your portfolio is not overly reliant on one region.
A common rule of thumb in financial planning is to clear expensive debt before increasing investments. That is because the return from debt repayment is certain, while investment returns are uncertain.
On that basis, the most logical order would often be to reduce or clear the 12.9 per cent loan first, continue building long-term investments through an Isa once the expensive borrowing is gone, and consider mortgage overpayments later if you wish.
That said, personal finance is not only about the numbers. Some people prefer to split a windfall, for example using part of it to reduce debt and part of it to invest.
That can help maintain good financial discipline while still improving your overall position.
The key point is that tackling high interest borrowing first usually provides the strongest guaranteed financial benefit.
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