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Student loans ... endowment mortgages. Your everyday financial queries answered

Here's a wheeze: students who don't need to make use of the official student loan scheme can still take out a loan, put the money into a Tessa in their own names and benefit from a tax-free return. Has the government deliberately planned to put money into the pockets of the children of the middle classes?

DR, Bedford

This is an interesting suggestion. As a general rule, borrowing to invest in the hope that the return on the investment will be more than the cost of borrowing the money is a dangerous game.

The advantage of your proposal is that the cost of borrowing is low and the return from a Tessa is fairly safe - and it's tax-free. The student loan scheme allows students on higher education courses to borrow between pounds 920 and pounds 2,035, depending on their year of study and where they live. The interest charge is equivalent to the annual rate of inflation. Hence, so long as the tax-free return on the Tessa is higher than this (as it invariably is at the moment), the student will end up in profit.

But there are some snags. First, a student has to start paying back the loan from the April after the course is over, providing he or she is earning at least a set figure at that time. With a typical three year course, the pay-back will start before the Tessa matures after five years. Secondly, what if the student invests the money from the loan but still requires a subsidy from the parent? There may be a cost to the parent in terms of any extra loan they have themselves which could otherwise be paid off (including the mortgage) or in terms of a lost investment return. For example, a parent could put their money into their own Tessa rather than subsidising a son or daughter. Parents doting on their child's financial acumen should not lose sight of this second point.

My partner and I are planning to get a large mortgage. We don't have any children but reckon it's still worth getting some sort of life insurance in case one of us were to die. An endowment mortgage automatically includes life insurance, but there has been so much bad publicity about them. Should we consider one? TL, Manchester

There may be nothing wrong with a good endowment policy which you keep up for the full term - typically 25 years. During those 25 years you pay only interest (but no capital back) to the mortgage lender. Then you pay back the capital on the loan with the proceeds of your endowment policy.

However, one of the main arguments against an endowment loan is that your circumstances may change before the 25 years are up. You may need to surrender your policy early and early cash-in values are notoriously poor.

Endowment policies are also believed to have aggravated the problem of negative equity. If people had taken out capital repayment mortgages, some of their debt would have been paid off and the shortfall between their loans and the lower values of their properties would have been smaller.

With a repayment mortgage you get no built-in life insurance but it is quite possible to buy a relatively cheap policy to run alongside to cover the mortgage.

Or if you prefer an investment-type loan, look into the pros and cons of a PEP-backed mortgage (Autif, the unit trust companies' association, has just published a free factsheet on PEP mortgages. Call 0181 207 1361). PEPs have more tax breaks than endowments. Even though you don't pay tax on the proceeds of an endowment policy, the insurance company pays tax on the investment returns. But returns in a PEP are tax-free. In addition, PEPs are more flexible both in terms of what you pay in and when you can cash in. You can get cheap life insurance to back a PEP loan, too.

q Write to Steve Lodge, personal finance editor, Independent on Sunday, 1 Canada Square, Canary Wharf, London E14 5DL, and include a telephone number.

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