Money: Low inflation turns the tables on endowment mortgages

After years of being out of favour, repayment schemes are all the rage.
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THE REPAYMENT mortgage is back in favour. The image of its main rival, the endowment mortgage, has been well and truly tarnished, and now another sparring partner, the PEP mortgage, is also down in the popularity stakes.

Repayment mortgages now account for 43 per cent of all mortgages taken out, up from 24 per cent five years ago.

Just 32 per cent of all home loans are now endowment mortgages, down from around 80 per cent in the last decade.

Lenders put the change down to low inflation. Sue Anderson, at the Council of Mortgage Lenders, says: "When inflation is low there is obviously an advantage to paying your mortgage off, but when inflation is high and is eroding the value of your mortgage, that's not the case."

There are four main types of mortgage repayment: with capital and interest repayment, each month's payment to the lender consists of interest due on the loan and a certain amount of capital.

In the early years, the payments are mostly interest and very little capital, and the balance shifts towards interest as the term of the mortgage goes on.

The other types are endowment, PEP and pension mortgages.

These are all interest-only mortgages, coupled with an investment product. The borrower pays interest to the lender and premiums into an investment product, the idea being that at the end of the term, the investment portion will have grown large enough to pay off the mortgage in full.

Repayment mortgages are generally slightly cheaper than others.

For a couple aged about 40, monthly payments on a pounds 100,000 loan over 20 years at a capped rate of 6.59 per cent would be pounds 818.28 a month, including term life assurance, according to the independent financial adviser Dawn Slater.

The monthly cost of an endowment mortgage for the same couple at the same rate would be pounds 828.82, while a PEP deal would cost pounds 848.21. Tax relief is available, and would cut these figures by around pounds 15 a month.

Which type of repayment you decide to opt for depends largely on your attitude to risk.

Endowment and PEP mortgages rely on the performance of investments. Opting for a capital and interest repayment mortgage is the safest way, says Ms Slater. "It's the only way you can guarantee to get the mortgage paid."

The main attraction of endowment and PEP mortgages is that the investment will perform well and provide an extra lump sum.

Some borrowers have found that their endowment policy is not even on track to pay off the mortgage, and have had to increase premiums.

And some of those who surrendered their endowment policies in the early years, perhaps because of divorce, found they got less money back than they had put in because of high charges levied at the start of the policy's life.

Anyway, the prospect of making a large profit is little more than a forlorn hope, says Philip Telford, of the Consumers' Association.

"You may have pounds 10,000 more, but after 25 years think how much that would be worth... and that's if you stay the course.

"Thirty per cent of people have to cash in their endowment policy in the first 10 years," he says.

Ms Slater defends endowment mortgages. Provided you do not cash them in early, traditional with-profits endowment policies have generally done well, she says.

The bad press has centred around certain mortgage providers, while others, including General Accident, have consistently come up trumps, she says.

PEP mortgages became popular in the Nineties. PEPs are far more flexible as investment products and charges are spread much more evenly. However, they are more risky than endowment policies.

Next April they will be replaced with ISAs, (individual savings accounts), and although PEPs can be transferred to ISAs, the choice of PEP has become more limited recently, ahead of the change.

Many people find that lenders and advisers steer them away from repayment mortgages and towards PEP or endowment mortgages. Repayment mortgages are not portable, it is claimed.

"It's a myth," says Philip Telford. "I don't think that there is a portability problem."

It is true that if you move house during the 25-year term, with a repayment mortgage you have to repay the mortgage and start again with a new term. But there is nothing to stop you taking a shorter mortgage term the next time.

However, in practice the temptation to take out another 25-year mortgage often proves too much to resist. "Most of the time, people want to keep their costs down," says Ms Slater. "The shorter the mortgage term for a repayment mortgage, the higher the monthly cost will be, because of the capital repayment element."

Financial advisers get more commission for selling an endowment mortgage than for the life insurance that usually goes with a repayment mortgage. Though the commission level is about the same, and can be 33 per cent of premiums paid in the first three years, a typical endowment policy premium would be around 10 times the premium of a term life assurance contract, says Mr Telford.

Of course, a good adviser will recommend the best product for the client, regardless of commission, but watch out for the bad ones.

Dawn Slater Associates: 01635 45325; Consumers' Association: 0171-830 6000; Council of Mortgage Lenders: 0171-440 2255