What is an endowment mortgage?
An endowment mortgage is quite simply a form of interest only mortgage. This means you’re not making any repayments on the lump sum you’ve borrowed to finance your home, you’re simply repaying the interest that is being charged on this borrowed figure. Then, when your mortgage deal comes to an end, you are required to repay the original figure you borrowed (also known as the capital) in full.
What makes an endowment mortgage different, though, is that the loan includes an additional savings product: an endowment policy, which is a form of life insurance that is redeemed in a single payment either after your death or when the policy has matured.
Endowment policies are normally available on a 10-20 year agreement, and if this agreement comes to an end before you die (aka it matures) then you will receive a cash payment during your lifetime.
Types of endowment mortgages
There are two main types of endowment policy – with profits and unit linked. The first has two bonuses, reversionary and terminal. Reversionary bonuses are an annual sum paid out if you keep up with your policy payments, before the total value of your savings is paid out in the form of the terminal bonus when your policy reaches maturity. The second does not necessarily include interim payments, but tracks the value of the money you’ve invested to the financial markets in order to determine your final payment value.
With an endowment mortgage, as well as paying off the interest you owe on the capital you’ve borrowed, payments are made to a life insurance firm who invest the money on your behalf. When the policy matures, the company uses the money it has built up to pay off your mortgage capital and then give you any funds left over.
What are the benefits of an endowment mortgage?
If you’re looking to purchase life insurance anyway, sometimes it’s cheaper to buy it as part of an endowment mortgage. Also, as endowment policies are linked to the financial markets, if the growth of your investment exceeds predicted rates then you could find yourself receiving a healthy lump sum payment when your agreement matures.
What are the disadvantages of an endowment mortgage?
Charges to set up an endowment plan can be relatively expensive and lenders tend to be less flexible if you need to take a payment holiday or adjust your repayments.
Also, because your endowment savings plan is effectively an investment, a poor market performance means your endowment policy could depreciate in value and you may be required by your bank or building society to pay more money towards covering the cost of your mortgage interest when the policy comes to an end.
Any form of interest only mortgage such as an endowment product is particularly risky in a recession or times of economic difficulty, as financial austerity leads to a fall in house prices in most areas. As you are not paying off the capital – the initial sum you borrowed to finance your purchase – then you run the risk of falling into negative equity, where the money you owe to the bank is greater than the sum you will receive if you sell your property.
Is an endowment mortgage the best option for me?
In general terms, an endowment mortgage is best suited to someone in a strong financial position. As there is a degree of risk associated with it, it’s not recommended for those on a tight budget with few savings.
However, if you can afford to contribute additional funds to your mortgage if things go wrong, an endowment mortgage can actually yield a nice little financial bonus should investing fall in your favour.
Endowment mortgages tend to appeal to mature borrowers who are investing in a property on behalf of someone else or who are looking to protect their partner and family in the long term by taking out a life insurance policy.
Anything else I need to know about endowment mortgages?
Endowment mortgages hit the headlines in the 1990s because many people were mis-sold them in the 1980s under the promise that their endowment policy would increase in value and result in a lucrative payment when it matured. Market changes meant this did not happen in some cases, resulting in borrowers having to make additional payments towards their mortgage or ending up in negative equity. Lending regulations, however, are much tighter today.
If you hold or have previously held an endowment mortgage that you think was mis-sold to you, contact the Financial Ombudsman for further advice on making a claim.