MONEY Q&A: There's no place for endowments

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The Independent Online
My partner and I are hoping to buy our first flat. We need more information on endowment mortgages. I recently heard one expert say endowment mortgages are old-fashioned and not suitable for anyone nowadays. Against that I understand that around one in three new mortgages are taken out on an endowment basis, suggesting they do serve a purpose. What do you think?

EM, London

Borrowers are often persuaded to take out an endowment mortgage by lenders motivated by commission. If a bank or building society sells you an endowment policy from a third party, namely an insurance company, it pockets a handsome commission. If you do plump for an endowment mortgage, buy one from an independent financial adviser. He or she will be able to look at all the policies on the market; most mortgage lenders will only sell endowments from one company.

With an endowment mortgage, you don't pay off any part of your loan until the end of the term of the mortgage. You only pay interest to the mortgage lender. At the same time, you pay endowment policy premiums that are invested in shares and other assets. The carrot dangled by sales people is that at the end of the mortgage and endowment policy term (traditionally 25 years) your policy could pay off your loan and leave you with a cash surplus.

This happy outcome was facilitated by the tax rules, but endowment policies no longer benefit from a benign tax regime. First, you could get tax relief on your endowment premiums. But that was abolished in the early 1980s. Then you could get tax relief at your highest rate of income tax on the mortgage interest. But this tax relief has been cut back in a series of Budgets in the 1990s and will be abolished next year.

Endowment policies require a long-term commitment. In practice, only a minority of endowments reach their maturity date because people's circumstances change. But if you stop paying your premiums or decide to cash in early, you usually get a poor investment return. You may get nothing back in the first few years.

And there is no guarantee you will have enough money to pay off your mortgage on maturity. Concern is growing that there will be a shortfall on many existing policies. Initially this was portrayed as a small difficulty involving a handful of customers who took out policies in the early 1990s. They were advised to increase their premiums. But as each year goes by, that small difficulty is developing into a major problem about which the life insurance industry has yet to come clean.

Endowment policy pushers say you can pay off your original mortgage after 25 years. By contrast, they argue, if you have a repayment mortgage you have to start your 25-year term all over again each time you move. This is not so. You could start a new repayment mortgage with a term shorter than 25 years.

In any case, with a repayment mortgage you will have paid off some of your mortgage by the time you move. You will have a bit more money to put down as a deposit on your next property, allowing you to buy something a bit more expensive. You are also less likely to have negative equity, where house prices have fallen and your outstanding mortgage is greater than the value of your home. Housing market cycles occurred long before the painful fall in property prices in the early 1990s. But in the past, property price falls were masked by high levels of general inflation.

Endowment policy pushers point to the benefits of life insurance which will pay off your mortgage if you die. But you pay for this. The older you are when you take out a policy, the greater the part of the endowment premium that will be used for insurance. Less will actually be invested. If you do want life cover, you can buy a relatively cheap life insurance policy. And if you have no partner or children or have adequate life cover elsewhere (through your job, for example), you may not need this insurance.