Endowment Mortgages

Endowment mortgages are an interest-only mortgage linked to an endowment policy, which can work either on a with-profits or a unit-linked basis. If the investment in the endowment policy grows at a reasonable rate, it is anticipated that the policy will produce enough to pay off the loan at the end of the mortgage term and even leave you a bit of extra cash as well. But there is no guarantee that this will happen.

In September 1999, the Association of British Insurers (ABI) introduced a code of practice to ensure that endowment mortgage holders were given regular information about the progress of their endowment policy towards paying off the mortgage. Under that original code, it was envisaged that information would be needed only in the later years of the mortgage and then only at five-yearly intervals. The inadequacy of this approach became clear as the stock market started its long slide at the start of 2000 and, from July 2001, a new code came into force requiring endowment providers to send out review letters much more frequently:

· The first review should be no later than three years after the start of the endowment mortgage.
· Subsequent reviews should be sent to you at least every two years throughout the term of the endowment
· You can ask for more frequent reviews (but not more often than once every 12 months).

These reviews have since become known as ‘reprojection letters’. They recalculate the return you might get from your endowment policy taking into account growth so far and standard growth assumptions and compare this with the mortgage loan to be paid off. The letters are colour coded. A ‘red letter’ signifies there is a high risk that the amount you’ll get back from the endowment policy at the end of its term will fall short of the amount needed to repay your mortgage in full. An ‘amber letter’ indicates there is a significant risk of a shortfall. A ‘green letter’ means you are currently on track to repay your mortgage.

Stock-market performance affects any shortfall. So, you could have a green reprojection letter at one review but, if the stock market falls, get an amber or red letter next time. Similarly, if you have an amber letter at one review, a rise in the stock market might mean you get a green letter next time. But, if you get a red letter, there would normally have to be a very substantial rise in the stock market before you returned to green, so you should usually consider other action to put your mortgage back on track.

The most obvious action is to increase the amount you save each month. You may be able to do this by increasing the premium you pay into the endowment policy, although you don’t have to do that. You could pay extra savings into another, quite separate investment for example, an ISA. If you already have other savings and investments, you might simple choose to earmark some of these to meet the forecast shortfall.

Other options involve altering your mortgage by, for example, replacing part or all of the endowment loan with a repayment mortgage or repaying a lump sum early. If you feel you were mis-sold an endowment mortgage for example, you would not have been comfortable with the risk of a stock market investment and your adviser did not check this you may have grounds to complain and seek compensation, but normally you should do this within the sooner of:

· Six years of receiving the bad advice, or
· Three years of the date you became aware there was a problem (usually the date you were first told your endowment would fall short of the amount needed to repay your mortgage), or
· Six months of receiving the second letter warning you that you have an endowment shortfall.

A useful aspect of linking your mortgage to an insurance policy, if you have dependants, is that the policy automatically gives you life cover, which would pay off the loan if you were to die during the term.

There are two major drawbacks with an endowment mortgage. As already discussed, there is a very real possibility that the endowment policy will not grow enough to produce a profit over and above the cost of borrowing. This means the endowment mortgage can end up costing you more than a repayment mortgage.

The second drawback is the very low cash-in value of the endowment policy if you stop paying the premiums in the early years. The costs associated with selling the policy (which include any commission paid to an adviser of salesperson) are intended to be spread over the full term of the policy. But if the policy stops early, these charges are set against the policy in full, even though the policy has had little time in which to build up much investment value. The result is that stopping the policy early can mean that you get back far less than you have paid in premiums, or even nothing at all. This makes endowment mortgages particularly inflexible if you run into problems keeping up the mortgage repayments. You may be able to alter the interest payments on the mortgage loan itself, but reducing or missing payments into the endowment policy might bring the policy to an end. A waiver of premium option might be at least a partial solution to this problem.

These drawbacks mean that endowment mortgages are not usually a good choice for anyone newly taking out a mortgage. But, if you already have an endowment mortgage, be wary of changing it. Stopping the endowment policy or cashing it in may crystallise the heavy charges discussed above. Your best option may be to carry on with the endowment mortgage. If you move house or remortgage without moving, it may be sensible to use the existing endowment policy to back a further interest-only mortgage, but you could look at taking out any top-up mortgage on a different basis. For example, if you are taking out a bigger loan, consider a repayment mortgage for the extra amount, or linking ISAs to the extra loan if it is on an interest-only basis.

Article Source: ABC Article Directory

James Miller is a freelance writer specialised in consumer credit, covering topics such as how to deal with bad credit, mortgages and insurance. He aims to help people navigate the financial industry.

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