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Endowment Mortgages were hugely popular in the 1980s and 1990s and were often sold alongside interest only mortgages. There has been a lot of problems and scandals around endowment mortgages and failure for the borrower to repay the capital to the lender at the end of the agreement means customers can possibly face serious consequences and lose their home.
In this article we look into the history of endowment policies and if they are suitable for you.
What is an endowment mortgage?
An endowment mortgage is an arrangement for the borrower to pay back the lender on an interest only basis and the capital is to be repaid by one or more endowment policies brought from an insurance company. Endowment policy are a type of savings plan where you pay into on a monthly basis and at maturity the proceeds will be intended to be used to pay off the capital loan on a mortgage and the possibility of a cash surplus for the borrower. This is funded by the savings a customer can make each month by paying interest only to the lender, compared to a normal capital repayment mortgage. A lump sum for the endowment policy is paid upon the end of its term or on the policyholder’s death, whichever is sooner, unless it is cashed in early. The borrower has two separate agreements, one with the lender for the mortgage and one with the insurance company for the endowment policy. Since they are separate agreements, the customer can make changes to either agreements as they wish.
There are different types of endowment policies to choose from and the most common types are with‐profits and unit‐linked.
With-profits policies are medium to long term investment funds, linked to the stock market and carries a guarantee to generate a certain amount if premium payments are paid. How with-profit policies work is that the customer’s premiums are pooled together and invested in the insurance company’s with-profits fund, managed by a professional investment manager, into different types of investments such as shares, bonds, property and cash. Annual bonuses are issued to the customer and added to their policy with a possibility of an additional terminal bonus at the end of the policy.
Non profit endowments are another type of endowment policy and pays a set amount on maturity. Premiums are usually lower than other policies which intend to make a profit and is sold with life insurance which can pay off a mortgage should a policy holder pass away before the end of term.
Unit-linked policies are tied directly to shares and carry higher risks for customers since there are no guarantees and the pay-out depends on the performance of underlying investments. Customer’s premiums are used to buy units offered by the provider and the policyholder can usually have a choice on which funds to invest in. The endowment policies’ value will depend on the current value of the units and how well the investments performed meaning the values can increase or decrease.
Whole of life endowment policies are sold alongside life insurance and is held for the rest of your life rather than a defined term. The idea is that it will pay off a lump sum or your mortgage should you pass away before your mortgage is paid off.
Endowment mortgage shortfall
Issues arise from endowment policies sold between 1980s and 1990s because many of the policies didn’t generate the lump sum predicted and created a shortfall for customers between the amount the endowment generated and capital owed on their mortgage.
Although most understood that there was no absolute guarantee of mortgages being repaid by endowment policies, many felt misled and been inappropriately mis-sold the product leading to a huge wave of claims and compensation made for the customers.
It is advisable for customers to check their projections with their provider to see if their policies are on track or expected to have a shortfall. If a customer is unsure that they will be able to use their endowment policy pay-out to cover the initial mortgage loan then it is advisable for them to switch partly or wholly from interest only to a capital repayment mortgage. It is wise to check early and get organised in case the capital mortgage loan needs to be repaid with other investments or savings.
With the rise of other schemes such as ISAs which are much more tax efficient, endowment policies are now not as popular as before although they still exist. Following the highly publicised scandals surrounding endowment policies, complaints from customers and compensation claims due to mis-selling, the industry is much more careful about the sale of endowment policies and risk warnings are outlined a lot clearer for customers are per laws and regulations. Please do not hesitate to contact us if you would like any further advice.