High street banks to offer PEP mortgages

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TWO high street banks are considering launching personal equity plan mortgages.

Barclays and Natwest are poised to offer PEPs as a method of repaying a loan. The entry the big lenders will boost the availability of PEP mortgages. Only 2 per cent of borrowers opt to pay their loans using this method.

Usually borrowers will only be offered a PEP mortgage if they go through an independent financial adviser.

Anyone taking out a loan from a bank or building society is offered either a repayment mortgage or an interest- only mortgage, where the capital is paid off using an endowment or pension.

Endowment loans have come under fire because a large proportion are surrendered after a short time and the policyholder loses money.

Poor investment returns have also led to insurers increasing borrowers' premiums to ensure policies pay off loans.

A pension mortgage pays off the loan from a tax-free lump sum taken on retirement. Contributions to the policy are made free from tax, and investment within the fund is also tax-free.

However, new personal pensions are only allowed a maximum of 25 per cent of the fund free from tax - so the pension has to pay at least four times the loan. Using a pension to pay off a loan also depletes the amount of money available for retirement.

A repayment mortgage pays off capital and interest over the period of the loan. Anyone opting for this usually also has to take mortgage protection to ensure the loan is covered if the borrower dies before the mortgage is paid.

The three repayment methods available for an interest- only mortage - pension, PEP and endowment - all ultimately rely on the performance of the stock market.

However, the tax and charges on the three vary. Contributions to an endowment are paid out of taxed income, but the proceeds are tax-free, provided premiums are paid for 10 years or three- quarters of the policy's term.

Investment in a PEP is not tax-free, but the fund accumulates free of income and capital gains tax. Charges on PEPs are lower than an endowment or a pension. Anybody taking out a PEP mortgage also has to take a term assurance policy to cover the value of the loan.

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