What is an Endowment?
An
endowment mortgage has two parts, a monthly interest payment to the mortgage
lender and a monthly payment into an endowment policy which is mainly invested
in stocks and shares. The policy is
usually arranged so that it ends when the mortgage loan ends, so that the
proceeds are available to use in repaying the amount borrowed. There are approximately 9.5 million
endowment policies linked to a mortgage.
During the 1980s and 90s many people chose to use endowments to repay their mortgages: interest rates were high, and the stock market was booming. Today interest rates have fallen to unprecedented levels, and stock market returns are lower. This has had an impact on endowments including those being used to repay mortgages. Borrowers have found the interest part of their mortgage payment has dropped significantly, but on average the investment performance of the endowment policy has also been reducing. Between April 2000 and March 2002, average mortgage interest rates fell from 7.74% to 5.75%, causing net interest payments on a £50,000 endowment mortgage to decline by £83 per month.
Why are Endowment Mortgages in
the News?
Because of the changes in the economic climate, the insurance industry has agreed with the Government watchdog, the FSA, a campaign to communicate to customers what this means for their mortgage. Insurance companies have been sending out letters advising policyholders of the possible future performance of the endowment policy, as part of the ABI Mortgage Endowment Code. For some policyholders, this means that there could be a shortfall in the performance of the endowment policy. The purpose of the letter is to encourage consumers to take action by making additional arrangements to repay any projected shortfall.
There are three main options open to policyholders; firstly to make changes to the mortgage loan such as switching the amount of the projected shortfall to a repayment mortgage or considering converting from an interest only mortgage to a repayment mortgage, either with the same lender or a different one. Secondly to start an additional savings plan so that the money saved could be used to pay off any shortfall. If £83 were to be invested each month, and earned a return of 5.75% per annum (ie the average mortgage rate in March 2002), these savings would grow after 5 years to £5,755 and after 10 years to £13,360. Finally, policyholders could vary the endowment policy, extending the term of the endowment (and mortgage) or topping up the endowment plan (where permitted by the company).
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