Could this be a red letter day?

Millions of endowment holders are set to find out whether their policy will cover their mortgage. But what do you do if you are one of the unlucky people likely to suffer a shortfall
Click to follow
The Independent Online

If you have an endowment mortgage you may have received one of more than five million letters, set to be sent out by insurance companies this year informing you whether your policy is likely to suffer a shortfall in paying off your loan or not.

If you have an endowment mortgage you may have received one of more than five million letters, set to be sent out by insurance companies this year informing you whether your policy is likely to suffer a shortfall in paying off your loan or not.

Endowment policies were extremely popular in the 1980s, when growth rates of 8.5 per cent were thought easily possible. Now that inflation and interest rates have fallen to 30 year lows, such growth rates are highly unlikely, meaning some endowment polices may not grow fast enough to pay off borrowers' home loans.

If you are likely to suffer a shortfall, what should you do?

First of all, a word about the letters, which are based on an industry standard and were drawn up by the Financial Services Authority (FSA). They are divided into three categories: green, amber and red.

You get a green letter if your endowment provider forecasts your policy "is currently projected to repay the target amount when it matures". The insurance company will advise you that "it is unlikely that you need to take any action now".

An Amber letter will say your plan may not pay out enough and you may wish to think about taking action. The red letter states bluntly: "We consider there is now a high risk that your plan may not pay out enough...We therefore strongly suggest you consider taking action."

One of the biggest endowment providers, Standard Life, has already sent out 600,000 green letters, 530,000 amber and just 10,000 red. This puts the problem into perspective. As an FSA spokesman put it this week: "Many people have done quite well out of endowments. That is the reason why we have not decided to undertake a wholesale review of them."

Say you've got a "red" letter. Or perhaps you are just concerned about your endowment anyway. What should you do?

You may be tempted to cash your endowment policy in. Never do this, or stop making payments, without taking proper advice.

There are often high charges in the early years. If your policy is only a few years old, the amount you would get back will probably be less than the payments you have made. You will also have to find another way of repaying your mortgage, and you may also need to pay for life insurance, which is included in the endowment policy.

Generally speaking, if your endowment has run at least a third of the way through its life, you would be much better off selling it than surrendering it. There are a number of brokers that specialise in buying and selling endowments.

Even better, if you can possibly afford it, is to hang onto your endowment until it matures and arrange to pay for all or part of your loan with a repayment mortgage. Repayment mortgages are much better than endowments in a low inflation, low interest rate environment like today. It pays to hang onto your endowment to maturity since most of its fastest growth happens towards the end of its life. Also, endowments often pay bonuses at the end.

In practical terms, the first thing to do is to track down all your mortgage paperwork. Check how long both the loan and the endowment policy have left to run. Then contact your endowment company to confirm exactly what they estimate the shortfall might be.

Remember, the company is only estimating a possible shortfall. There is every possibility that your policy will grow fast enough to pay off your loan. But, to be prudent, you should take action if they advise it.

What are your options to cover a shortfall? The best one is to keep the endowment going and switch to a repayment mortgage to pay off your existing loan. Even if you have a very large mortgage, if you can possibly afford it, this is the best deal.

Check the conditions of your mortgage. If it is a flexible mortgage, then you should be able to make overpayments without incurring penalties. If you are paid an annual bonus by your employer, you could use this to make up the shortfall on your mortgage. Or you could dip into savings. This method does require considerable self discipline. You must also check when the capital repayment is credited to your account, so you know when you will benefit from lower payments.

If these options aren't open to you, there are other, less attractive possibilities. You could start a savings scheme, such as an ISA, to build up a further lump sum that you can put towards paying off your loan. If the ISA invests in equities, however, you will be dependent on the future performance of the stockmarket to pay off your home loan.

* You can get further advice from the FSA Helpline on 0845 606 1234.

* Brokers who buy endowment policies: Policy Portfolio, 020-8343 4567; Beale Dobie, 01621 851 133

Looking for credit card or current account deals? Search here

Comments