Endowment
Endowment mortgage explained
The customer pays only the interest on the capital borrowed, thus saving
money with respect to an ordinary repayment loan; the borrower instead makes
payments to an endowment policy. The objective is that the investment made
through the endowment policy will be sufficient to repay the mortgage at the end
of the term and possibly create a cash surplus. Up to 1984 qualifying insurance contracts including endowment policies
received tax relief on the premiums known as LAPR (Life Assurance Premium
Relief). This gave a tax advantage for endowment mortgages over repayment.
Similarly MIRAS (Mortgage Interest Relief At Source) made having a larger
mortgage advantageous as the MIRAS relief reduced as a repayment mortgage was
repaid. This tax incentive toward endowment mortgages is not often
commented on in the media when they discuss endowment mortgages. An additional reason in favour of an endowment was that many lenders charge
interest on an annual basis. This meant that any capital repaid on a monthly
basis is not removed from the outstanding loan until the end of the year thus
increasing the real rate of interest charged. In such a situation, payments into
an endowment might benefit from any growth from the moment it is invested.
Henceforth, the net investment return required for the endowment to pay the
loan, would be less than the average mortgage interest rate over the same
period.
Problems with endowment mortgages
The underlying premise with endowment mortgage policies being used to repay a mortgage,
is that the rate of growth of the investment will exceed the rate of interest
charged on the loan. Toward the end of the 1980s when endowment mortgage selling
was at its peak, the anticipated growth rate for endowments policies was high
(7-12% per annum). By the middle of the 1990s the change in the economy toward
lower inflation made the assumptions of a few years ago look optimistic. Regulation of investment advice and a growing awareness of the potential for
regulatory action against the insurers lead to reduction in anticipated growth
rates down to 7.5% and eventually as low as 4% per annum. By 2001 the sale of
endowments to repay a mortgage was virtually seen as taboo. Shortfalls
Financial regulations introduced compulsory re-projection letters to show
existing endowment holders what the likely maturity value of their endowment
would be assuming standard growth rates. This in turn lead to a dramatic rise in complaints of mis-selling and spawned a
secondary industry that 'handles' complaints for consumers for a fee, even
though they can pursue it themselves for free. In many cases the insurer or broker responsible for the original advice have
found in favour of the policyholder and have been required to restore their
customers to the financial position they would have been in had they taken out a
repayment mortgage instead. As of July 2006, UK banks and insurance providers
have paid out approximately £2.2 billion in compensation. For a mortgage enquiry please contact
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