Endowment mortgage seeks to regain market acceptance

MSR and her fiancee are getting married later this year and have been house hunting. They recently met with their building society manager and, writes Ms R, were "a bit surprised when he asked us is we were interested in buying an endowment mortgage, which he described as very good value, mainly because of high stock market returns in the last couple of years, and lower policy costs.

"Our finances are quite healthy at the moment and we are in a position to afford the extra premiums that he showed us, but I am concerned about buying such a mortgage because of other negative comments I have read. Can you provide a more up to date view?

Our reader is quite right to be cautious about taking out an endowment mortgage. The market in these investments for investments is what they really are collapsed about two years ago after a lengthy spate of bad publicity here and in Britain about misinformed selling and bad advice, high policy costs and poor investment returns. What emerged was that most people who purchased life assurance endowment mortgages did not understand what sort of endowment they were buying (i.e. unit linked or with profit) did not appreciate the level of investment risk they were taking, and did not realise that they might have to increase the level of their monthly payments simply to ensure that the endowment policy would be of sufficient value to pay off their loan at the end of the usual 20 year term.

Central to the failure of many of these policies was the fact that so many policyholders encashed them early most were surrendered within seven years and only a tiny percentage survived to maturity when much publicised final bonuses were paid out. Because of high set up costs, most policy holders who encashed early suffered some kind of financial loss.

Department of the Environment figures show that in 1992 nearly 40 per cent of all mortgages were endowments. The vast majority of those policies would have been volatile, unit linked products with no guaranteed sums assured i.e. the amount a with profits policy promises to pay towards the repayment of the mortgage loan, regardless of how investment markets have performed.

That percentage of endowment mortgages is quite staggering when you realise that not only were real investment returns from some of the biggest funds failing to reward the costs and risk levels associated with them, but that tax relief for life assurance policies had been withdrawn by that stage and that it was only a matter of time before mortgage interest tax relief was also scaled down.

Without the additional tax deductions, high cost endowment mortgages (complete with 90 per cent commissions for the lender) made even less financial sense and within a year their sales were down to 17.5 per cent of all mortgages. A small rally in the first two quarters of 1995 has since faltered and the latest Department figures show that sales have collapsed to just 5.7 per cent.

Some lenders and insurance companies continue to argue however weakly that endowment mortgages are "a good buy" for people who understand what they are getting into. They claim that because commissions have been reduced from 90 per cent of the first year's premiums to the equivalent of 3 per cent for every year of the contract, (ie. 60 per cent for a standard 20 year mortgage) this has automatically improved early values.

Some companies, but not all, can show that they have also reduced their own costs. They also continue to insist that long term equities are a good investment choice and claim that no endowment mortgage holder who has kept their policy for the full period of their contract has ever faced a cash shortfall at the end. However, they fail to mention how endowment holders who took out their policies in the 1970s enjoyed higher inflation/returns and considerably greater tax relief than those who took out theirs in the late 1980s and 1990s.

Now that mortgage interest relief has been further reduced and inflation is reduced to around 2.5 per cent per annum there is very little to recommend an endowment mortgage in which the investor pays interest only for 20 years with no repayment of the capital sum. Market volatility makes a unit linked endowment unsuitable for most homeowners who may be forced for whatever reason to encash their policy early. With profit endowments smooth out the market ups and downs but only adequately repay the holder if they are held to full term.

Our readers are best advised to take out a standard annuity (also known as a repayment) mortgage and with their spare cash, buy a high performing, reasonably costed investment policy/fund which ideally will produce sufficient returns to pay off the balance of their mortgage before the end of their 20 year home loan contract. There are plenty of options for varying type and risk on the market which will give them equity exposure, and they should consult an independent financial adviser to help them make the best choice.