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Endowment Mortgage Shortfall

Although there are some worrying signs about mortgages and pensions in the long term, we don't have to sit back and wait for financial disaster to strike. Taking control of the situation sooner rather than later will reap dividends. Although the example used is a very specific one, the lessons to be drawn have widespread relevance.

Here's a salutary lesson based on a problem currently facing an estimated four million UK homebuyers, who opted for the financial equivalent of a disaster movie to pay off their mortgages.

Endowment mortgages are based on the idea that when you take out a mortgage, you pay the mortgage lender enough over the term of the loan to cover the interest on the amount you choose to borrow. To pay off the core amount borrowed, you take out an endowment policy, typically from a life assurance company. Your payments are invested in the stock market in the expectation that over a number of years - normally 20-25 years - increases in the value of shares will generate a lump sum equal to or higher than the original sum borrowed.

Endowment policies were very popular in the UK from the late 70s through to the early 90s, with sales peaking around 1988. At that time, over 80 per cent of all mortgages taken out were structured around endowment policies.

Unfortunately, endowment mortgages have not lived up to their billing. Early in 2004, it was revealed that 80 per cent of all endowments will almost certainly not achieve the performance needed to pay off the associated mortgages. On average, the shortfall for these failing policies is likely to be around £5,500 each. With an estimated 8.5 million policies in force, UK homeowners are going to have to find an extra £37bn from somewhere to pay off their home loans.

There are two main reasons why endowments underachieved. Firstly, there was a structural problem in that they paid very high upfront commission to the salespeople. This meant under just about any circumstances investors would not receive positive investment returns for the first few years of their policy. Secondly, the collapse of the stock market between 2000 and 2003 turned all the overoptimistic financial predictions of stock market performance that underpinned endowment policies to dust. After peaking at 6,930 at the end of 1999, the blue-chip FTSE 100 index (which measures the value of the UK 's 100 largest listed companies) fell by over 50 per cent in the next three and a bit years. Endowments suffered badly in the bear market.

These days, borrowers steer well clear of endowments: only 5 per cent of new mortgages have an endowment sold alongside them. But millions of UK borrowers with mortgages due to reach the end of their term between 2010 to 2025 face a significant problem.

As I mentioned in the introduction to this idea, you may not be facing this specific problem, and your mortgage may be totally under control. But how confident are you, for example, about your pension arrangements? Or providing for your long-term health needs? Or giving financial support for your children when they go to university?

Any future financial challenge where you can't look ahead with confidence is an opportunity to take some pre-emptive action. Taking some positive steps today - even if they are very small steps - will make life easier in the future.


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