Get your sums right and turn a mortgage shortfall into a windfall

Six million are affected, but endowment policyholders can stay on track and even reduce their repayments
Money net

The colours red, amber and green will be obsessing endowment policyholders at the moment. The second batch of letters informing them whether they face a shortfall on their mortgages have been arriving on doormats over the past week.

For most, they make depressing reading. Some 35 per cent of the 10 million home owners with endowments have received red letters urging them to take immediate action because their policy is unlikely to pay off their mortgage at the end of the investment term. A further 26 per cent have had amber letters suggesting they consider taking action to cover a potential shortfall. The lucky remainder will get green letters because their endowment is on track to pay off their loan.

If you face a potential shortfall, your insurer will advise you to invest extra money into your endowment policy. But this is not the best course of action.

"Don't throw good money after bad," advises Mark Harris, director of Savills Private Finance, a mortgage broker. "With low interest rates and falling stock markets, endowment mortgages have failed to perform, leaving borrowers with a significant mortgage shortfall.

"But if you have an endowment, you shouldn't surrender it or pay more money into it. You can supplement the shortfall, without having to fork out any extra cash each month, by remortgaging."

For example, a borrower with an endowment mortgage of £100,000, paying 5.75 per cent interest on a Halifax loan with 15 years left to run, would currently be paying £479.16 per month. If the borrower were to remortgage to a two-year discounted product at 3.79 per cent with the Woolwich, his or her monthly payments would reduce to £315.83.

The saving – £163.33 per month – would enable the borrower to convert £32,500 of the loan into a 15-year repayment mortgage (assuming the endowment mortgage was required to repay up to £78,000 of the home loan). This should cover the endowment shortfall without the need to increase monthly outgoings. And once the discount period expired, the borrower could remortgage again, without penalty, to another deal.

It is unlikely that you will be able to afford to remortgage all of your interest-only loan to a repayment vehicle, but remortgaging part of it will reduce the likelihood of a shortfall – even if the stock market underperforms. You can also keep the endowment going so that you don't miss out on the benefits of allowing it to run full term.

"It is also worth remembering that the projection [of the return on your endowment] is built on assumptions – nobody knows what is going to happen to the stock market," says Donna Bradshaw, director at independent financial adviser (IFA) Fiona Price & Partners. "If your endowment is with a good company such as Standard Life or Norwich Union, you should continue it because of the smoothing effect and the guarantees built in. Plus, if it's not with-profits, it may not be suitable for selling anyway."

The other problem is trying to find an alternative investment producing the same returns (let alone higher ones) as the endowment. Savills Private Finance has not sold an endowment policy in the past four years. Instead it recommends backing an interest-only loan with a variety of bonuses, share options and other investments such as individual savings accounts.

However, if you've had enough and want to give up your endowment, it is worth selling it on the second-hand market rather than surrendering it to your insurer as you will almost certainly get a better deal. The traded endowment policy (Tep) market is worth about £500m a year, and sellers who take this route get, on average, 10 to 15 per cent more for their unwanted policies.

First check the surrender value on your policy with your insurer. Then contact a couple of companies which purchase endowments, such as Beale Dobie or Surrenda-link, to find out whether they will offer you a better deal. The service is free, as those purchasing endowments on the Tep market pay the charges.

If you do decide to sell , make sure you get adequate life cover. "If you sell your endowment, you will lose your life insurance cover and critical illness if that is built into the plan as well," warns Ray Boulger at mortgage broker Charcol. "And you need to be aware that if you took out the endowment 10 or 15 years ago, the cost of life insurance will have gone up, so you will be paying more. And if you have developed any medical problems during that time, this cost will also increase. But most people need some sort of life cover."

Many won't even know they are facing a potential endowment shortfall: a survey by National Savings and Investments shows that one in seven of those who move home don't give their new address to their financial providers. If this is you, contact your insurance company as soon as possible.

A free guide for policyholders wishing to sell their endowment policy is available from the Association of Policy Market Makers at Beale Dobie also has a free guide to selling an endowment. Call 01621 851133 or Chartwell, 01225 446556.

He showed his policy the door

Charles Burnett, 51, a commercial marketing manager, decided to give up on his endowment policy with Britannia Building Society after being told there was a possibility it would be several thousand pounds short of meeting its target by the end of the investment term.

"I received notification from Britannia that it might end up undershooting by £10,000 to £12,000," he says. "To prevent this, I was advised to increase the payments. But I realised it would still give me no guarantee that my endowment would meet its target, so I wasn't going to go down that route. There was clearly a case for looking around for an alternative."

Mr Burnett, who lives in Edinburgh, decided to move his interest-only mortgage from Northern Rock to Intelligent Finance. He converted it to a repayment home loan and gave up on the endowment entirely.

"Not only do I feel much more comfortable about the fact that my mortgage is guaranteed to be paid off now, but my payments have actually come down," says Mr Burnett. "My savings are also taken into account [through offsetting] and I can make extra payments if I want to, so it's a good opportunity to repay my mortgage in a shorter time."