Information about Endowment Mortgage
An endowment mortgage is a mortgage loan arranged on an interest-only basis where the capital is intended to be repaid by one or more (usually Low-Cost) endowment policies. The phrase endowment mortgage is used mainly in the United Kingdom by lenders and consumers to refer to this arrangement and is not a legal term.
The borrower has two separate agreements. One with the lender for the mortgage and one with the insurer for the endowment policy. The arrangements are distinct and the borrower can change either arrangement if they wish. In the past the endowment policy was often taken as additional security by lender. That is, the lender applied a legal device to ensure the proceeds of the endowment were made payable to them rather than the borrower; typically the policy is assigned to the lender. This practice is uncommon now.
Up to 1984 qualifying insurance contracts (including endowment policies) received tax relief on the premiums known as LAPR (Life Assurance Premium Relief). This gave a tax advantage for endowment mortgages over repayment. Similarly MIRAS (Mortgage Interest Relief At Source) made having a larger mortgage advantageous as the MIRAS relief reduced as a repayment mortgage was repaid. This tax incentivisation toward endowment mortgages is not often commented on in the media when they discuss endowment mortgages.
An additional reason in favour of an endowment was that many lenders charge interest on an annual basis. This meant that any capital repaid on a monthly basis is not removed from the outstanding loan until the end of the year thus increasing the real rate of interest charged. In such a situation, payments into an endowment might benefit from any growth from the moment it is invested. Henceforth, the net investment return required for the endowment to pay the loan, would be less than the average mortgage interest rate over the same period.
Regulation of investment advice and a growing awareness of the potential for regulatory action against the insurers lead to reduction in anticipated growth rates down to 7.5% and eventually as low as 4% per annum. By 2001 the sale of endowments to repay a mortgage was virtually seen as taboo.
This in turn lead to a dramatic rise in complaints of mis-selling and spawned a secondary industry that 'handles' complaints for consumers for a fee, even though they can pursue it themselves for free.
In many cases the insurer or broker responsible for the original advice have found in favour of the policyholder and have been required to restore their customers to the financial position they would have been in had they taken out a repayment mortgage instead. As of July 2006, UK banks and insurance providers have paid out approximately £2.2 billion in compensation.[1]
An endowment policy
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The borrower has two separate agreements. One with the lender for the mortgage and one with the insurer for the endowment policy. The arrangements are distinct and the borrower can change either arrangement if they wish. In the past the endowment policy was often taken as additional security by lender. That is, the lender applied a legal device to ensure the proceeds of the endowment were made payable to them rather than the borrower; typically the policy is assigned to the lender. This practice is uncommon now.
Why have an endowment mortgage
The customer pays only the interest on the capital borrowed, thus saving money with respect to an ordinary repayment loan; the borrower instead makes payments to an endowment policy. The objective is that the investment made through the endowment policy will be sufficient to repay the mortgage at the end of the term and possibly create a cash surplus.Up to 1984 qualifying insurance contracts (including endowment policies) received tax relief on the premiums known as LAPR (Life Assurance Premium Relief). This gave a tax advantage for endowment mortgages over repayment. Similarly MIRAS (Mortgage Interest Relief At Source) made having a larger mortgage advantageous as the MIRAS relief reduced as a repayment mortgage was repaid. This tax incentivisation toward endowment mortgages is not often commented on in the media when they discuss endowment mortgages.
An additional reason in favour of an endowment was that many lenders charge interest on an annual basis. This meant that any capital repaid on a monthly basis is not removed from the outstanding loan until the end of the year thus increasing the real rate of interest charged. In such a situation, payments into an endowment might benefit from any growth from the moment it is invested. Henceforth, the net investment return required for the endowment to pay the loan, would be less than the average mortgage interest rate over the same period.
Problems with endowment mortgages
The underlying premise with endowment policies being used to repay a mortgage, is that the rate of growth of the investment will exceed the rate of interest charged on the loan. Toward the end of the 1980s when endowment mortgage selling was at its peak, the anticipated growth rate for endowments policies was high (7-12% per annum). By the middle of the 1990s the change in the economy toward lower inflation made the assumptions of a few years ago look optimistic.Regulation of investment advice and a growing awareness of the potential for regulatory action against the insurers lead to reduction in anticipated growth rates down to 7.5% and eventually as low as 4% per annum. By 2001 the sale of endowments to repay a mortgage was virtually seen as taboo.
Shortfalls
Financial regulations introduced compulsory re-projection letters to show existing endowment holders what the likely maturity value of their endowment would be assuming standard growth rates.This in turn lead to a dramatic rise in complaints of mis-selling and spawned a secondary industry that 'handles' complaints for consumers for a fee, even though they can pursue it themselves for free.
In many cases the insurer or broker responsible for the original advice have found in favour of the policyholder and have been required to restore their customers to the financial position they would have been in had they taken out a repayment mortgage instead. As of July 2006, UK banks and insurance providers have paid out approximately £2.2 billion in compensation.[1]
References
External links
- Information from the Financial Ombudsman Service
- FSA Endowment Mortgage Complaints
- A Useful Guide to Endowment Mortgages
- Endowment Selling: A Guide for Endowments
A mortgage loan is a loan secured by real property through the use of a mortgage (a legal instrument). However, the word mortgage alone, in everyday usage, is most often used to mean mortgage loan.
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An endowment policy
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Mortgage Interest Relief at Source, or MIRAS, was a scheme introduced by the government of the United Kingdom in 1983 in an effort to facilitate a greater level of borrowing for house purchases; it allowed borrowers tax relief for interest payments on their mortgage.
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