Analysis: Safe as houses? Red letters spell alarm to homeowners

Policy holders are being informed in colour-coded letters whether they face a shortfall on their home loans. Few will get good news

Buying a home, once thought to be the safest and wisest thing people could do with their money, is turning out to be one of the riskiest.

Buying a home, once thought to be the safest and wisest thing people could do with their money, is turning out to be one of the riskiest.

In the 1990s millions of borrowers were devastated by negative equity when the value of their homes fell below their mortgages. House prices have since reversed their decline and begun a seemingly inexorable climb, but some homeowners are still finding themselves out of pocket.

The latest victims are the millions of borrowers who took out endowment life insurance products. Rather than repaying a chunk of their mortgage each month, endowment policy holders only pay the interest and then invest every month in an endowment scheme which, when the mortgage matures, is meant to cover the outstanding value of the home loan.

Unfortunately, because of low interest rates and a tumbling stock market, these endowments have failed to appreciate as planned and, in millions of cases, are not projected to cover the mortgage.

Anybody who is concerned whether they are among the unlucky ones will soon have their prayers answered – or fears confirmed – by a letter from their insurance company.

The correspondence is coded green, amber or red. Those receiving green letters can relax: their policy needs to grow at only 6 per cent or less a year to pay off their mortgage. An amber letter means that the endowment has to grow at between 6 per cent and 8 per cent a year: in other words, there is a serious risk that it will not match the mortgage. But it is the red letters that will really set the alarm bells ringing. They signify that a policy has to grow by more than 8 per cent a year, a very tall order if there are only a few years left to go.

So far 1.25 million of these letters have been posted, of which more than six in 10 are to people with policies in the red or amber categories. Spread across the whole population, this suggests that as many as 6 million households, involving about 15 million people, face a fretful future.

The problem goes back to 1984, when Nigel Lawson, as Chancellor of the Exchequer, abolished tax relief on life insurance premiums. Before then, borrowers were able to pay higher premiums, which comfortably covered the final repayment because of the tax relief available.

One example from those days of much lower house prices was a £6,000 mortgage, covered by the basic payout on the endowment, which after 20 years produced bonuses of £24,000, four times the mortgage. The policyholder kept that money to spend as he pleased. The premiums could have been a fifth of what they actually were and still have paid off the mortgage, but at the time that did not matter.

Once tax relief on life insurance premiums was abolished that type of plan became much more expensive, and all the more so when Mr Lawson's successor, Gordon Brown, finally scrapped mortgage tax relief two years ago, adding £17 to the average monthly repayment (in fairness, it had been whittled away by several Chancellors before Mr Brown).

Sellers responded by driving down monthly premiums, in effect placing less and less reliance on the basic guaranteed sum of money promised to come from these policies, and more and more reliance on their annual bonuses – which depended on the money generated from the payments by a rallying stock market.

In 1988, 84 per cent of mortgages were endowment-linked. But as years went by, sales people competed with one another by promising lower and lower premiums for any given size of mortgage and endowment, which meant increasingly heavy reliance on the bonuses to make up the difference. Now the risks have come home to borrowers: they may not have realised it, but they were playing the stock market as much as any City trader. When share prices took a turn for the worse, so did their mortgages.

The Association of British Insurers (ABI), the industry's trade body, says: "A slowing in the rate of growth of endowment policies is to be expected following the recent relatively poor performance of the stock market, and reflects a decline in investment returns generally."

Anna Bowes, of the independent financial adviser Chase de Vere, says: "The crux of the problem is aggressive selling. If sales people pretended that your endowment policy was going to grow by 10 per cent a year, then the premiums you would have to pay would be lower than if it was going to grow by only 5 per cent a year."

The Financial Services Authority, which regulates the selling of endowment policies, said yesterday: "We have always said that these are long-term investments, and with stock markets down 20 per cent it is no surprise that bonuses are down too. If you understood the risks at the outset and are uncomfortable now, you should look at it again. But if you were not told of the risks then you should complain to your endowment provider. If you are not satisfied you should ask the provider for a deadlock letter and complain to the Financial Ombudsman Service."

But, as the ABI points out, while stock markets have been dull in recent years, interest rates have been low too, so borrowers could have afforded to pay back more or save more elsewhere. The ABI said: "It is important to remember that consumers faced with lower investment returns are at the same time benefiting because interest payments on their mortgage are lower as a result of low inflation and lower mortgage rates."

That may be of little consolation to borrowers who thought that their endowment policies were sufficient to repay their home loan, and that therefore they were free to spend the money they were saving from those lower mortgage payments. Having in effect – and perhaps unwittingly – called the stock market wrong, they face a grim choice between digging deep into their pockets or possibly having to sell their home.

Of course, the stock market may resume its ascent and let borrowers off the hook. But either way, the crisis is sure to raise fresh questions about mis-selling scandals and the way in which some insurance companies inflate their profits and directors' salaries by persistently exposing their customers to undue risk.

It will also lay to rest the myth that investing in bricks and mortar is always the safest thing you can do.

How to escape the endowment trap

First, contact your mortgage lender. It will want to keep your business. The obvious option is to repay part of your loan but some lenders impose penalties for doing this.

If your lender is amenable, you can increase monthly payments. Then that part of the mortgage is guaranteed to be paid off.

Extend the term of your endowment and mortgage. This will cut monthly payments. But there may be additional charges and you will end up paying more.

Top up your endowment policy. This could be throwing good money after bad, and you are likely to face more charges.

Put additional money in a separate investment, such as a tax-free stock market individual savings account (Isa). This will work only if you have five years or more to go and are confident you can out-perform your endowment. Otherwise, save through cash Isas.

Shop around. The mortgage market is competitive at present, so go to an independent financial adviser (IFA) or visit bank and building societies' branches or websites. Check on strings attached to your existing deal.

You may need to dispose of your old endowment policy. Ask the provider how much it will give you, then see if one of the specialist firms who buy and sell policies if they can get you a better price. The biggest is Surrenda-link, phone 01244 317999.