Buy
To Let
An endowment
mortgage is
a mortgage
loan
arranged on
an
interest-only
basis where
the capital
is intended
to be repaid
by one or
more
(usually
Low-Cost)
endowment
policies.
The phrase
endowment
mortgage is
used mainly
in the
United
Kingdom by
lenders and
consumers to
refer to
this
arrangement
and is not a
legal term.
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 can
change
either
arrangement
if they
wish. In the
past the
endowment
policy was
often taken
as
additional
security by
lender. That
is, the
lender
applied a
legal device
to ensure
the proceeds
of the
endowment
were made
payable to
them rather
than the
borrower;
typically
the policy
is assigned
to the
lender. This
practice is
uncommon
now.
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
incentivisation
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
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.
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