Straight repayment is not always the right move

YOU WOULD need to live on the moon not to have heard about the so- called endowment mortgage scandal. But not everybody sees it like that.

The Financial Services Authority (FSA) hit out as it sought recently to calm fears about endowment mortgages. A spokesman says: "Some of the Press coverage has been inaccurate. Notwithstanding this, it has been helpful in making people aware that they may need to take action if they have a projected shortfall."

Its view is that holders of endowment policies have fared at least as well as they would have done had they had a repayment mortgage.

Endowments, horror of horrors, are still appropriate contracts - but in the right circumstances.

The FSA confirmed that it would not be launching a comprehensive mis-selling review into endowment mortgages. Additionally it confirmed the view of chairman Sir Howard Davies, who says: "Endowment holders have on average done quite well in recent years, better in fact than original projections."

But the selling of "low cost" and "low-start" endowments has been the nub of the problems. Changes to the tax regime, and the use of overoptimistic growth forecasts by the companies themselves, have led to the current position where it looks as if some endowment maturities may not cover the loans with which they are associated.

It is imperative that these are looked at and any incidents of misselling exposed.

With all endowment mortgages, only interest is paid on the loan and a separate life policy and savings plan is established that builds up a lump sum to repay the capital at the end.

Under the repayment method, interest - and a little capital - is repaid each month. Initially, most of the repayment is interest and significant amounts of capital are only repaid towards the end of the loan.

At the peak of the housing market boom in 1988, 83% of all mortgages were backed by endowments. Today, the Council for Mortgage Lenders shows endowment mortgages accounting for only 19% - and decreasing. Repayment mortgages now account for 57% of mortgages and this figure is increasing.

But is this rush into repayment mortgages justified?

There are some circumstances in which they are suitable. The most obvious is when you are unlikely to move house every few years.

This requirement for stability is absolutely essential. With most repayment mortgages, when you move house, the mortgage is paid off with the proceeds from the sale of the old house.

The first few years will have been spent primarily paying off interest rather than capital. This means that if you move every few years the mortgage debt will not decrease significantly. But the average mortgage with Halifax, for example, is only seven years and with Nationwide it is between six and seven years. Halifax says it is "very rare" for a mortgage to be held for 25 years. So moving within less than a third of the original mortgage term means that relatively little meaningful capital gets paid off.

And when you move house (frequently trading upwards), you start again. On a typical mortgage, after seven years only about 13% of the capital has been paid off. After three years it is reduced by only 5%. And so on.

So, the average length of mortgage appears to argue against repayment mortgages. But there are other circumstances when a repayment mortgage might be appropriate.

If you think you will inherit substantial amounts of money, you could pay off the debt that way - provided, of course, there are no other pressing financial requirements.

A repayment mortgage is certainly easier to reschedule if you feel you may have periods when it might be difficult to meet the regular monthly amounts.

But the first rule of intelligent money management is always to have an emergency reserve.

Additionally, if you feel you are likely to leave the British housing market before the end of the mortgage period, a repayment loan may be appropriate.

An endowment is most profitable when it runs the full term.

Don't be stampeded Nowadays, the employment market is much more flexible, and the job for-life is fast disappearing. The distinction between full and part-time employment is now less clear. Also, the divorce rate is much higher these days, usually forcing the realisation of property assets, among others.

In summary, the market for repayment mortgages has changed significantly.

So if you are one of the 57% of purchasers taking out a repayment mortgage, and you fit into one of the above categories, fine. But if not, it may be that you are being stampeded into an inappropriate financial profile.

Endowments may be inflexible, expensive, underperforming investments. And there is a widely-held view that savings-related life assurance is a waste of money. Yet potential house purchasers unhappy with endowment policies have other options than just the repayment model.

If you want life assurance you should buy just that. Term assurance is the obvious answer, and then you can put your money into "real" investments.

Many large lenders now recommend an individual savings account as a suitable way to repay capital.

The most important thing is to decide which method of repaying a mortgage is likely to suit your circumstances best - not just today but for the next couple of decades.

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