Tide turns against endowment policies

Vivien Goldsmith on changes in mortgages

Endowment mortgages are becoming increasingly unpopular as borrowers realise there is no guarantee they will repay the loan at the end of the period.

At their peak in 1988 more than 83 per cent of mortgage loans were backed by an endowment, but that has shrunk to less than 60 per cent.

The heyday of endowments coincided with the peak of the share market and people who took them out then are most in danger of having to increase premiums to avoid a shortfall at the end. The shorter the term, the more likely the endowment will need extra premiums to keep the performance on track to repay the mortgage.

Max Rosen, managing director of Securitised Endowment Contracts (SEC), which deals in second-hand policies, said: "My message is: don't worry if you have a 25-year endowment. But if you have 10-to-15-year policy you could have a problem. If equity markets pick up sharply then everything changes."

Few people who bought endowments really understood the way they worked and that there was no guarantee of repayment.

For instance, when someone takes out an endowment to repay a £60,000 loan after 25 years, the premium asked would depend on the assumption made about returns delivered by the annual and final bonuses. In 1989, for a 29-year-old man, Norwich Union decidedon premiums of £75 a month, which required a return of 8.2 per cent to meet the £60,000 target. If returns were 7 per cent the sum on maturity would be £13,900 short. But if returns were 10 per cent a year then there would be a surplus of £12,800.

The average assumption for people taking out a mortgage now is 7.5 per cent, while Halifax uses a cautious 7 per cent.

The Office of Fair Trading is due to report on the selling of endowment mortgages next month. The director of consumer affairs, John Mills, said: "People have had insufficient information to make choices. We suspect that endowments have been sold so heavily because of high commissions."

Regulators have moved to reduce the pressure on consumers to buy endowments. Advisers now have to explain why they have opted for this method and they have to show how much is siphoned off in charges and commission payments. This has led insurance companies to restructure their endowments so less is taken out in the initial years.

Amanda Davidson, a partner with the independent advisers Holden Meehan, said: "It's not the death of the endowment. But it is a good thing that clients know there are other choices and they will not automatically be filtered into an endowment. Many clients are risk-averse and would not want to go into a personal equity plan.

"I don't like unit-linked endowments which can drop in value. You might as well have a PEP. But low-cost conventional with profits are good for some clients, as about a third of the loan is guaranteed."

She said that those who envisaged moving frequently would probably be better off with an endowment as a repayment loan would have to be restarted with each move. Borrowers can start with an endowment and top it up with a PEP mortgage when they move to a more expensive home.

Mixed loans are becoming more popular and account for more than 15 per cent of the mortgage market.

Philip Scott, general manager of Norwich Union, said that endowments had been changed to make them easier to understand. Unitised with-profits policies have completely replaced the conventional with-profits polices at Norwich Union.

The loss of significant tax relief on mortgages and low inflation means that borrowers are keen to shrink their mortgage debt when they can. "It is easier to get a repayment mortgage out of the way," Mr Scott said.

"The financial services industry has regarded endowments as a kind of sacred cow, but if you look at Europe, the States or Australia, the equity based mortgage is non-existent. They want to repay their mortgages when they can."

Ian Darby, marketing director at the mortgage brokers John Charcol, said: "Our stance is middle of the road. Endowment mortgages have been oversold - and over criticised. Historically they have done a wonderful job. Pre-1991 they have produced compound interest of 12 to 13 per cent. But it's a very different set of circumstances now."

The regulators allow endowment mortgages to rely on growth rates of 5, 7.5 or 10 per cent a year. "If someone is going to expect growth at the higher levels there is a risk they might not have enough to repay the loan,'' Mr Darby said.

In practice insurance companies undertake to check the progress of endowments every five years along the way to ensure that there is no nasty shock. Guardian and Royal have already asked investors to increase their monthly payments.

SEC will project the effects of any cuts in bonus rates on policyholders' own policies for a fee of £10. Call 081-207 1666.