The DIY PEP package

Rather than let your lender loose, it may pay to create your own investment strategy, says Simon Read

Just over a year ago the Halifax, Britain's biggest mortgage lender, introduced the concept of the PEP mortgage to its customers. Since then more than half of new Halifax borrowers have chosen - or rather, they have been sold - this new way to repay their home loan, in place of the increasingly unpopular endowment mortgage.

While the total number of PEP mortgages sold by the Halifax is surprising when compared with other lenders, many financial experts give the thumbs up to what they say should offer at least as good investment growth as an endowment, but much greater flexibility. Because of this flexibility, rather than taking a PEP mortgage package, borrowers may be better off in creating their own.

A PEP mortgage comprises two main parts: an interest-only home loan, and the PEP, which acts as the investment vehicle. The objective is for the PEP to grow enough to pay off the home loan.

Taking the Halifax's package, known as the Tax Free Home Loan, means taking the investment vehicle offered by the Halifax. This may or may not be a good idea. The PEP is a unit trust which invests in UK companies, mainly blue chips, and which is managed by Halifax Fund Management.

Sensible investors should have a good look at the performance of different fund management houses and then try to find a firm with an investment strategy that is sympathetic to their needs. Charges also come into the decision-making process.

Other companies offering a PEP mortgage package include NatWest, the Woolwich, the insurance company Standard Life, plus Legal & General, and a number of fund managers including Fidelity, Ivory & Sime and Newton, all of which have set up schemes being offered through independent financial advisers.

By going down the do-it-yourself route you'll be able to choose your own investment strategy. For instance, you could put your first tax year's PEP allowance of pounds 6,000 into an index tracker fund, such as those offered by Virgin Direct, Direct Line, or Legal & General.

These funds aim to reproduce the FT-SE 100 index, the Footsie, and as long as the index rises, the fund will grow. But for your second year PEP you might want to diversify into a growth fund or, in a year when we're facing possible financial uncertainty after interest rate have risen, invest in overseas markets.

Of course, this involves a great deal of interest and know-how on your part, both in monitoring your existing funds and planning future investments. If you're already put off by the thought of all that work then it would obviously be easier to choose a PEP package and get someone else to do that work for you. But bear in mind that you could be tying yourself into one provider's PEP for up to 25 years if you link it to that company's mortgage.

By buying separate parts of the PEP mortgage package yourself, you can spread your cash around different fund managers, which should also help lessen the chance of backing the wrong company.

It could be a good idea, for instance, to choose one of the guaranteed PEPs offered periodically. While these may not grow as much as the best performers, they do guarantee that you won't lose any of your capital, which is always a risk with any kind of equity investment. Investment over a long term, say the 25-year length of a mortgage, means changing your investment strategy as you get older.

Long-term capital growth is your ultimate aim but as you approach the mortgage pay-off date, you'll have to start considering lower-risk investments, and monitor your fund regularly to ensure that it will achieve your aims. With a little bit of luck you could end up being able to afford to pay off your mortgage much earlier than planned, or use some of your capital to pay off part of the mortgage to reduce the eventual debt.

The latter strategy will mean you'll pay less interest on your loan but may also reduce the risk of your fund falling prey to a stockmarket crash just before you come to the end of the mortgage term. The other thing you'll need to take into account is that with endowment mortgages, an element of life insurance is included in the endowment. With PEP mortgages, as with repayment mortgages, you may need to buy separate life cover.

If you want to take the easier route of a packaged PEP mortgage the provider should also include an insurance element. But check the flexibility of these deals and ask questions such as whether you can pay off the mortgage early, or in parts during the term of the loan. Most importantly, you must decide whether the risk element of a PEP mortgage suits you. If it doesn't. It pays to stick with a repayment loann