Your Money: Stiff terms of endowment

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ENDOWMENT policies have been sold hard in recent years. They now back more than three quarters of mortgages.

These are hybrid policies, designed to offer a way of saving to pay off the loan with a dash of life insurance in the meantime.

The whole deal is pretty inflexible. The premium level is set by the lender, who uses the insurers' guidelines about expected returns. In recent years, the assumptions have been so conservative that policies maturing now deliver huge cash mountains as well as paying off the mortgage.

Home buyers should not regard this as a windfall. These are investment returns that they have paid for with higher than necessary premiums. If they had been free to vary the premiums during the term, or save hard and stop when there was enough in the kitty to pay off the loan, they would not have had to endure the extra enforced saving.

But endowments by their very nature are inflexible beasts.

The assumptions about the returns are coming down fast, and home buyers embarking on a new endowment policy will find that they are asked to pay much higher premiums than someone setting out a couple of years ago.

For instance, a customer taking out a pounds 60,000 loan with the Leeds Permanent Building Society last year would have been told to embark on an endowment (from Norwich Union) with a premium of pounds 80.35 a month. But this year, the same loan requires the backing of a policy with premiums of pounds 91.52 a month - an increase of 13.9 per cent.

This may not be hugely significant in relation to interest of something like pounds 360 due on the loan - a small change in interest rates can have a much bigger impact. But it is an indication that previous expectations of returns from the policies have been a long way adrift.

The philosphy underlying with-profits policies is designed to cope with undulating investment returns. There is a guaranteed annual bonus, which gradually inflates the value of the policy, and then a final bonus of around the same amount again to reflect the way the investment has performed over the whole period.

The good and bad years are cancelled out with small touches on the wheel.

But it seems that investment managers are now facing a much more radical shift - towards low returns in a low-inflation world. That calls for a wholesale change in the way that with-profit investment funds pay out from the pot.

Those holding 25-year endowments with one of the better-performing life offices, such as Commercial Union, should have built up enough to repay their loan in full if they are at least halfway through the term. Those with less successful life offices may have to wait until three quarters of the term has run its course.

Yet they keep on paying.

Many mainstream lenders, such as the Halifax or Cheltenham & Gloucester Building Society, will accept interest-only loans if they can see a plan for repayment some time, or means of paying interest for evermore.

So a personal equity plan savings scheme, an existing share portfolio or the prospect of inheriting a parent's property may look like a good bet.

THE pressure to take an endowment comes from the handsome commission payments that are made by the insurance company every time one is sold. Some lenders have come to rely on this commission income as a crucial plank in their financial structure.

So the hard sell goes on. Indeed, some of the best deals, such as low fixed-rate mortgages, are conditional on taking out an endowment.

Getting locked into the endowment for probably 25 years may prove a high price to pay for a mortgage rate that will only last a couple of years.

At least the old practice of cashing in all the existing policies on moving house and taking out fresh ones is dying. Cashing in offers poor value. Therefore, home movers are taking out shorter-term policies to cover any increase in the loan size.

So, someone 15 years into an endowment may have settled for a 10-year policy to provide the extra cover needed for a larger loan on moving. Although these policies taken out in the last few years may give disappointing returns, the surplus generated by the older policy will probably more than balance them. .

The message is that when it comes to home buying, there really is no need to get tied up in such an inflexible deal.