CONSIDER this investment proposition. Over the next six years, you save in monthly instalments. At the end of the period, assuming the investment has grown at 5 per cent a year, you might get back a little less than you paid in.
Yes – less than you paid in, even assuming a decent return on the underlying investment, thanks to some swingeing charges. Tempted? No.
Well, I wasn't tempted either. But like millions of other home owners, I am facing a shortfall on my endowment
mortgage and this cheeky proposition came from the company through which I have my policy – Scottish Life – as a means of meeting the funding gap.
The scale of the endowment mortgage shortfall problem is significant. Sales of endowment mortgages surged during the 1980s, reaching a peak in 1988 – the year in which I took out my mortgage – when they accounted for over 80 per cent of all mortgages issued. They appeared to be an attractive alternative to repayment mortgages – householders paid interest only on the mortgage loan, and then made separate regular payments into an endowment policy, with the aim of building up a lump sum to pay off the loan at the end of its term. At that time, they were also tax-efficient.
But since then, major problems have emerged with endowments which have left people wondering what to do with their policy. Projections of future returns proved optimistic, meaning that on many endowment policies the lump sum will be insufficient to repay the entire mortgage loan at the end of its term. In 2005, the Financial Services Authority (FSA) estimated that more than two million households were facing a shortfall on mortgage endowments. They found that the average shortfall was £7,200, and that almost one-third of these households had not yet taken any action to make up the shortfall. In the next few years, the problem is likely to become particularly acute, as 25-year policies taken out in the 1980s mature.
In my case, the shortfall is estimated at nearly one-third of my mortgage sum. So, like millions of others, I have been receiving "red letters" from Scottish Life informing me of my shortfall and reminding me that I should be doing something about it before I am due to repay my mortgage loan in 2013. Fair enough – that is what they should do under the Code of Practice drawn up by the Association of British Insurers (ABI). But is it not rather cynical to offer a top-up product with such exorbitant charges to consumers already facing substantial shortfalls?
Having spent 20 years in the investment industry, I am used to reading financial small print, but it still took me some time to deduce the charging structure proposed by Scottish Life on this product: "During the first three years 85 per cent of your premium will be used to buy units. Thereafter 101 per cent of your premium will be used to buy units." In other words, in each of the first three years of this six-year product, Scottish Life is deducting a hefty 15 per cent of the investment. In addition, there are charges on the funds in which premiums are invested.
Alasdair Buchanan, head of communications at Scottish Life, said: "The charges reflect the costs we would incur in setting up and running a policy of this type over a short period".
So why offer such a short-term product at all? Policies such as mine contain a guarantee that the proceeds will repay the mortgage amount at maturity, subject to reviews.
Buchanan says that Scottish Life felt contractually obliged to offer customers an option which maintains this guarantee – even though the maturity value of the top-up plan itself is not guaranteed and the plan may be subject to further reviews. However, he also acknowledges that investment in this product may not be the most appropriate course of action for many policy holders. Consequently, the offering letter stresses this point, lists possible alternatives and recommends that customers take independent financial advice.
So what should people facing a shortfall on your mortgage endowment policy do?
The FSA provides clear, useful information in a fact sheet, Will your investment or savings plan pay off your mortgage?
It outlines a number of ways of making up a shortfall and lists the pros and cons of each. In summary, this means saving more. According to the FSA, the options include:
• Asking your lender to switch part of your mortgage – the amount of your projected shortfall – to a repayment method.
• Asking your lender to convert your whole mortgage to a repayment method.
• Repaying part of your mortgage early by paying off a lump sum, or by overpaying each month, or by extending the term of the mortgage.
• Starting an additional investment or savings plan by using a cash savings account or using a stocks and shares individual savings account (ISA).
• Making changes to your existing investment or savings plan by extending the term or paying in more each month.
The FSA points out that some options may provide more certainty than others. It also suggests that, for advice about your own circumstances, you should consult a professional adviser.
As for myself, I have been making regular payments into a low-cost investment trust savings plan for a number of years. I am hoping that when my mortgage term expires, I will have saved enough to make up the shortfall. At least it means I felt able to turn down Scottish Life's offer.
If you are facing a shortfall the first port of call should be an independent financial adviser who can review your entire money situation to help you decide on the best option.
CASE STUDY
When trouble threatens, the time to act is now
LYNN Hewitt, 44, a project manager, and her husband Chris, 48, who live in Dalgety Bay with their 12-year-old son Harry, took out an endowment policy with Standard Life several years ago. For the first few years this seemed a sound investment and it looked like it would pay off their mortgage in time, but then the situation changed and it was clear they were facing a shortfall – in common with many policy holders.
Lynn explained: "Standard Life endowment policies did better than those from other providers who were facing problems with customers having shortfalls at a much earlier date. But about three years' ago it became clear from the annual forecast from Standard Life that our policy was not going to deliver the return we needed to cover our mortgage when the 25-year period was up. We realised quite a large amount would be outstanding so we decided to cash it in.
"I went to Albannach Financial Management, a firm of independent financial advisers in Edinburgh, for a full financial review and they were excellent. Everything was explained in plain English and they helped me restructure all my finances. I cashed in my policy and invested a small amount in a capital and interest mortgage.
"Anyone facing a shortfall should take professional advice first before considering the companies who advertise to buy your policy."
Jason Hemmings, director of Albannach FM, said: "
If someone has a shortfall on their policy they could consider surrendering it to get back on track and review all their mortgage and other financial arrangements at the same time."
• Albannach FM in association with The Scotsman is producing a free Guide to Mortgages. To request a copy call 0800 953 0223 or e-mail mymortgages @albannachfm.co.uk
WHAT TO DO WITH YOUR ENDOWMENT POLICYTHE Association of Policy Market Makers (APMM) – whose members buy and sell with-profits endowment policies – said January is shaping up to be a peak month for disposing of policies, fuelled by Christmas bills hitting doormats. The APMM has come up with a list of questions for people who are thinking of disposing of their policies:
1 Can the policy be made "paid up" ie not having to pay any more premiums?
2 Is it possible to take a premium holiday?
3 What are the accumulated bonuses to date? How do these compare to surrender value? The accumulated bonuses could be more.
4 How long has the policy run for? If it is less than six years, the value will not be significant.
5 What is the value of the policy? Log in to endowmentcheck.co.uk – it gives details about the impact of bonuses falling and rising. Use the site to establish a guide to the value of your policy.
6 If the policy has been taken out to meet a mortgage payment, does it deliver a shortfall against the mortgage target?
7 Could you get more than surrender value by selling your policy?
