Stay in for 25 years, or lose out

Endowment mortgages combine an interest-only loan with a life policy whose premiums the named borrower has to pay every month, and whose proceeds are used to repay the specified sum on maturity, generally after 25 years, writes William Raynor.

The bulk of the monthly payment - perhaps pounds 400 out of pounds 460, for instance - covers interest on the loan, and the rest of the payment goes into the life policy whose premiums are invested in securities and equities. To achieve full repayment and, if possible, leave the borrower with a lump sum as well - as most endowments are said to do - this investment has to produce average returns higher throughout the period than effective rates of mortgage interest.

How many people have endowment mortgages? Hard to tell, precisely. But from less than 20 per cent in the early 1980s, endowments peaked in 1988 at 84 per cent of gross mortgage advances of pounds 67bn, and three years ago, according to the Council of Mortgage Lenders, accounted for 60 per cent of mortgages worth pounds 57bn. Now, endowments declared as such have fallen to a third of all new mortgages, although their actual share may be a bit higher.

Three kinds of endowment are sold: traditional "low cost with-profits", which guarantee the medium-term bonuses reflecting investment performance, flatten peaks and troughs and are probably the safest and most popular; "unitised with-profits", which express benefits in terms of the policy's current aggregate value; and "unit-linked", whose returns mirror changes in the market value of the units in which the premiums are invested. In each category, policies and charges vary from company to company.

Best buys? Because many people move or split up "before term", those endowments that are "low charge and high surrender value" are best. These, said the OFT's 1995 report, could "out-perform straight repayments on most scenarios" and, towards maturity on a pounds 50,000, 25-year mortgage, cost pounds 3,200 less than some with "high charges and low surrender". Best companies? For with-profits in particular, Equitable Life, Friends Provident, General Accident, Legal & General, Norwich Union, Scottish Provident, Scottish Widows and Standard Life.

Any other pluses? Not many, it seems. On average, at early surrender a fifth of the way through, compared with straight repayments, the OFT found they would cost an extra pounds 600. For those with lower incomes and other borrowings, extra costs of even a few pounds a week can prove critical.

Endowments are also less tax-efficient than interest-only mortgages backed by PEPs or pensions, because life funds lost relief on premiums in 1984 and are subject to both income tax and capital gains. Cuts in Miras (Mortgage Interest Relief at Source) to 15 per cent beneath a pounds 30,000 ceiling have reduced any advantage bestowed on endowments by rebates on amounts fixed until maturity.

Lower inflation since the 1980s has meant that, as the value of sums borrowed has eroded less rapidly, there has been more pressure on borrowers to repay their debts quickly instead of taking out endowments and waiting for a lump sum after 25 years.

To make the most of endowments, that is what you need to do. Hence, although they are often sold on flexibility, they actually lock you in. In theory, if you sell, you can keep the life policy going on its own or transfer the mortgage to your next property. In practice, like the OFT, you may find this process less expensive with straight repayments. And if you have a joint endowment mortgage and are separating, one of you has to sign over your rights on the joint-life policy, or it has to be surrendered completely. If you want to keep your mortgage comparatively simple and certain, an endowment is probably not your answer.

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