Endowments cause concern: Maria Scott explains why financial advisers are worried about a type of home loan that gained popularity during the Eighties

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The Independent Online
'PLEASE can you help me. My 23-year-old daughter is buying a house and is being bombarded with advice to take an endowment mortgage. One saleswoman introduced to her by an estate agent telephoned her three times in one day. Is an endowment the right thing?'

This plea came from an Independent reader this week. As the housing market shows early signs of recovery it is probably not an unusual dilemma.

Sales of endowment mortgages grew rapidly in the Eighties to account for about 80 per cent of new loans and an ever-larger chunk of lenders' profits through hefty commissions earned on the policies.

The monthly cost of an endowment mortgage may look low compared with a traditional repayment loan at present, but independent financial advisers are worried about their inflexibility.

Karina Challons, senior planner with the adviser Murray Noble, says: 'I think endowments linked to mortgages could have problems in the next few years because of reduced investment returns.'

With an endowment, the borrower pays interest on the whole sum to the lender and an insurance premium to an insurance company. This pays for the investment plan and includes life insurance cover. The insurance premium will vary depending on borrowers' age, sex and possibly their state of health and whether they smoke.

With a repayment mortgage the borrower pays a sum to the lender to cover interest and a capital repayment. The borrower may also pay a monthly premium for a basic life insurance policy to repay the loan if he or she dies.

Halifax Building Society and Abbey National, the country's two largest lenders, have supplied a range of figures for repaying a pounds 60,000 mortgage over 25 years. The figures cover payments by a single man aged 29 and a single woman of the same age. Figures were also supplied for a couple, a man of 39 and a woman of 34.

The endowment loan came out cheaper in all cases, although the gap between endowment and repayment was largest for the couple. Abbey National quoted them a monthly payment on the endowment mortgage of pounds 420.65, of which pounds 343.44 was interest and pounds 77.21 was endowment premium.

The repayment mortgage would cost pounds 20 more at pounds 440.48, including a pounds 27.14 mortgage protection insurance policy. But the arithmetic of endowment mortgages is such that at times of high interest rates they begin to work out more expensive.

Cost is not the only factor to bear in mind. Miss Challons says: 'A few companies are already starting to recommend that policyholders increase their endowment premiums to ensure that the mortgage is covered. If borrowers cannot afford to do this the policy may not provide enough to pay the loan.'

She sees this as a greater risk with the unitised with-profit policies coming on to the market than with traditional with-profit policies.

Miss Challons points out that borrowers who cash in their endowments early may get back less than they put in. It is difficult, if not impossible, to take a break from paying endowment premiums. So they can be onerous if the borrower is short of money.

Since endowment mortgages are based on interest-only loans, it is not possible - as with a repayment loan - to reduce the monthly cost by spreading it over a longer period.

Miss Challons says it can make sense to have an endowment for up to pounds 30,000. This is the ceiling for receiving mortgage interest tax relief. The full payment to a lender on an endowment will receive relief, whereas on the repayment loan the capital portion will receive no tax relief.

But on the whole, she prefers repayment loans for first-time buyers. She takes the view that borrowers should concentrate on repaying mortgage debt as quickly as possible.

They may well want to save or invest to repay chunks of the loan, but it is better not to have a mortgage dependent on an endowment policy. Other forms of savings, such as personal equity plans, can be used to repay an interest-only mortgage.

It is possible to pay off chunks of an endowment loan before the end of the term, but the borrower is still saddled with the endowment, its early-surrender penalties and fixed premiums.

'Some people like with-profit endowments because they smooth out fluctuations in the stock market,' says Miss Challons. 'I am not against them as savings vehicles but they should not be linked directly to the loan.'

Many second-time buyers already have endowment loans. Miss Challons recently dealt with a client who wanted to move house and increase his mortgage from pounds 40,000 to pounds 100,000. His building society recommended topping up his present endowment to cover a pounds 100,000 loan.

'I recommended he keep the present endowment but take the rest of the loan on a repayment basis over 20 years,' she says.

Lenders continue to defend endowments strongly. Halifax argues in favour of them on the basis of cost, the inclusion of life cover, tax relief and the possibility of a surplus at the end of the loan. However, staff are now briefed to avoid recommending them to certain people including single people with no dependents, where the need for life insurance is debatable.

DOLLY DHINGRA, a 26- year-old office administrator at the Independent, has just moved into a pounds 43,000 two-bedroom house in Stratford, east London. She is a first-time buyer and chose a 20-year repayment mortgage with Halifax Building Society.

'The building societies I approached said the endowment was cheaper and that most people have endowment loans,' she says.

Dolly was at first convinced by the arguments but spoke to several friends, including one who is a solicitor and another who is an estate agent, and discovered they had repayment mortgages.

Other friends who had taken out endowment loans seemed to regret the decision, says Dolly.

She reconsidered and decided she liked the idea of steadily paying her debt off through a repayment loan.

'The repayment loan seemed old-fashioned and very secure,' she explains. 'Who knows what the markets are going to do tomorrow?'

'I chose a 20-year term instead of a 25-year one because I will save on interest in the long run and I can afford the higher repayments now.'

(Photograph omitted)

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