How to end the
mortgage endowment misery
Got a poor-performing endowment? Here's my view on what to do with it.
Millions of people saddled with endowment-linked mortgages must be wondering
what on earth is happening to their policies.
At least two thirds of the nine million endowment policies originally taken
out to pay off borrowers' home loans are unlikely to hit their target, with
some shortfalls running into tens of thousands of pounds.
Conventional wisdom has told us to stick with these policies. It is now time
for a re-think.
What you can do if you've got an endowment shortfall
There are three main options:
1. Top up the existing endowment. Most insurers have created endowment top-up
policies that can run alongside the main one.
Generally, advisers do not recommend taking them out. Not only might you
face continuing poor performance, there is also the issue of tax: if you
have a policy for less than 10 years your policy may not qualify for tax
2. Take out an alternative tax-free investment, such as an ISA. This would
only suit someone prepared to accept even greater stock market volatility
than a generally less risky endowment.
3. Switch to a repayment mortgage. This means converting part, or all, of
the loan into a repayment, usually by the amount of any predicted shortfall
plus a bit more just to be on the safe side. This way, repaying the mortgage
at the due date is virtually guaranteed.
The Financial Services Authority has produced a guide to what you can do
if you have an endowment.
What about the endowment itself?
That then leaves the question of what to do about the endowment itself. Up
to now, conventional wisdom has generally been to maintain payments wherever
possible and affordable.
This is because, even though no longer linked to the mortgage itself, an
endowment remains a reasonable long-term savings vehicle.
Meanwhile, cashing in the endowment (known as 'surrender'), not only means
the saver misses out on a terminal bonus at maturity, in the case of with-profits
It also risks a substantial penalty for those who have only kept the policy
going for a few years. Most policies levy high initial charges and their
'break-even' point where the value of the endowment is equal to the
contributions made only happens after eight to 10 years.
Make the policy paid-up
If the policyholder simply cannot afford to keep contributions into the endowment
while also opting for a repayment mortgage, the advice is to make the policy
This means halting future contributions into a policy but still letting it
run until maturity. While payouts may be lower, this avoids having to pay
hefty surrender penalties.
Conventional wisdom is challenged
The problem with generic advice is that when confronted with reality it can
turn into a load of old cobblers.
Weak stock markets and the poor performance of endowments means maturity
returns are being reduced year after year. This trend is likely to continue
for at least another year, perhaps several more, even if markets recover.
Meanwhile, if a policy is left paid up, what happens is that heavy initial
charges continue to be deducted from the policy.
At the same time, the policyholder will be paying for the life insurance
element of the endowment, which is taken from underlying returns. Given that
most endowment-linked life cover is quite expensive, this means further inroads
into the sum saved to date.
Stay or go?
So how do you go about calculating whether it makes sense to surrender?
Here is an example, based on a real-life scenario I was involved in recently.
A friend of mine with a mortgage started in 1986 borrowed a further £8,000
in 1994 for some home improvements. As with so many other people, he took
out another endowment, designed to mature at the same time as the main policy
Despite making monthly payments of £26.68 over nine years, he was recently
told that he would face a significant shortfall at maturity.
Indeed, even if the policy grew by 5.6 per cent a year for the next eight
years, he would only receive about £4,550.
What should he do? This is how did the sums:
Check the surrender value. Here, he found that despite having paid in about
£2,900 in the past nine years or so, his surrender value would only
Had the policy been taken out with a highly-regarded insurance company and
there were a few years left to run, he might have been able to sell it on
the second hand market, through a so-called traded endowment
firm. These can sometimes deliver a further 10 or 20 per cent on top of the
surrender value. But in his case, the endowment was with a firm whose policies
no-one wants to touch.
To find out more about selling endowment policies, click here for Moneyextra's
Calculate the effect of investing the £1,500. Assuming a typical variable
rate of about 5.6 per cent, using it to repay a chunk of the mortgage would
deliver 'returns' of around £2,300 over eight years in terms of reduced
Calculate the effect of increased contributions into the mortgage. If he
diverted that monthly £26.68 into the mortgage instead, his extra payments
would be worth about £3,200 over the next eight years, assuming the
same rate of interest.
Deduct the cost of life cover. My friend's policy offered both life and 'critical
illness' insurance, which pays out on diagnosis of 'dread diseases' like
heart attacks, strokes or cancer.
The cheapest £8,000 of life and critical illness cover for himself and
his wife, over eight years is £6.50 a month. For bog-standard life cover
the cost is £5 a month.
Paying for the life cover separately reduces the amount he could put towards
his mortgage to about £20 a month. At a rate of 5.6 per cent, his 'return'
would be roughly £2,400 over eight years.
Add the sums up. In his case, the total 'return' from diverting both future
monthly payments and the lump sum from the surrender of his policy towards
the mortgage would be about £5,500, or £4,700 with the life cover.
This compares with a total return of £4,550 from the policy, assuming
annual growth at 5.6 per cent until maturity.
Given that his policy would have to grow by about 5.9 per cent to match the
£4,700 from just putting the money towards his mortgage something
which he believes is unlikely to happen my friend's decision was to
take the money and run.
One more thing...
My friend's insurance company is one of those recently fined by the Financial
Services Authority (FSA), the financial watchdog, for endowment mis-selling.
It has set aside large amounts to compensate those wrongly advised to take
If he were to make a claim, might a decision to surrender early imperil his
chance of winning compensation for having been mis-sold a policy?
Not according to the FSA. Regardless of whether a firm has been fined or
not, as long as a request for a review of the policy sale has been made to
one's insurer, it is quite acceptable to surrender or sell the policy on
in the second-hand market.
If mis-selling is proved, the basis on which redress is paid generally involves
assuming that the individual concerned took out a repayment mortgage at the
time and then calculating how much would have been paid off in the intervening
years, minus the cost of life insurance, set at a 'fair' rate over that period.
Of course, this ignores the issue how to make an effective complaint. I will
come back to that at a later date. Meanwhile, to see how the Financial Services
Ombudsman determines whether mis-selling took place and how redress is
calculated, click the link below:
So, for anyone who feels they have been mis-sold a policy, the sensible course
of action is to complain to your insurer. Then do the sums above and stay
or leave - based on what you find. Good luck...
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