Endowment Mortgages

Endowment mortgages

An endowment mortgage is a mortgage loan arranged on an interest-only basis, the capital to be repaid by one or more endowment policies. The phrase endowment mortgage is not a legal term; it is simply used by lenders and consumers (mainly in the UK) to refer to this arrangement.

The borrower has two separate agreements: one with the lender for the mortgage; and one with the insurer for the endowment policy. The arrangements are distinct and the borrower may change either of them. In the past the endowment policy was often taken as additional security by the lender, for instance by ensuring that the proceeds of the endowment were made payable to them rather than the borrower. This practice is uncommon now.

Advantages of an endowment mortgage

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 aim is that the endowment policy will be sufficient on maturing to repay the mortgage at the end of the term, possibly even with a cash surplus.

Up to 1984 qualifying insurance contracts (including endowment policies) received tax relief known as LAPR (Life Assurance Premium Relief) on the premiums. Similarly MIRAS (Mortgage Interest Relief At Source) made having an endowment mortgage relatively advantageous as the decrease over time of interest repayments on a repayment mortgage meant decreasing MIRAS relief. These tax incentives in favour of endowment mortgages are not often commented on in the media.

Problems with endowment mortgages

The underlying premise with endowment mortgages is that the rate of growth of the investment will exceed the rate of interest charged on the loan. Towards the end of the 1980s, when endowment mortgage selling was at its peak, the projected growth rate for endowment policies was high (7-12% per annum). By the mid-1990s, lower inflation rates made these projections look optimistic.

Regulation of investment advice and a growing awareness of the potential for regulatory action against the insurers led to a reduction in projected growth rates down to 7.5% and eventually as low as 4% per annum. By 2001 the arrangment of new endowment mortgages had virtually ceased.

Shortfalls

Financial regulations introduced compulsory reprojection letters to show existing endowment holders what the likely value of their endowment would be on maturing, assuming standard growth rates. Many endowment holders have complained of mis-selling, which in turn has spawned a secondary trade in "handling" complaints on consumers' behalf for a fee (even though the consumers can pursue it themselves at no charge).

In many cases the regulators have found in favour of the policyholder and have required the insurer or broker responsible for the original advice 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.

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