Finance endowment mis-selling: Don't fear the red letter day

Endowment mortgages only make up a fraction of today's home loans, but those still with endowments need to act now to ensure they are able to pay off their mortgages.

The Financial Services Authority calculates that 2.2m households have endowments with a shortfall of £7,200 on average. There are two problems with this type of loans: poor investment performance, and poor financial advice.

For many years, endowment mortgages had many benefits. Rather than making monthly repayments of capital as well as interest, buyers opted for a cheaper, interest-only home loan and bought an endowment policy to run alongside it.

The insurance company would invest the endowment premiums in shares, bonds, property and cash. The aim was to pay off the mortgage and provide a cash lump sum. The policies also included life assurance, and the Government granted tax breaks.

In the 1970s and early 1980s, high inflation eroded the cost of the interest-only mortgage in real terms, while the endowment continued to grow. Home owners who took out endowments in the 1960s and 1970s sometimes enjoyed substantial surpluses.

But in the 1980s, insurers started to sell "low cost" endowments, which aimed only to pay off the mortgage. But to work, these plans relied on strong investment performance - performance that failed to materialise.

The second problem with endowments is how they were sold. In many cases, insurance salesmen were less than frank about the potential disadvantages of the plans. By the end of 2004, the big insurance firms had dealt with 695,000 mis-selling complaints and paid out more than £1.1bn in compensation.

The FSA is now worried about the few home owners who have not yet dealt with their shortfall, and will be issuing further guidance for them in the next few weeks.

Most insurance companies have also set time limits for complaints over endowment mis-selling, which must be at least three years from when it tells the home owner about the problem. The vast majority will have already received letters with a shortfall projection, known as "red" letters. The three-year deadline starts with that letter.

Not all complaints about endowments will be upheld, of course. The FSA stresses that receiving a red letter does not automatically mean you are entitled to compensation. That will only be awarded if the insurer, or the Ombudsman, accepts the home owner was mis-sold the policy. Poor investment performance alone is not enough.

And even if home owners do intend to complain, they still need to act to address the endowment shortfall. This could be by increasing their endowment premiums, paying into another investment vehicle, such as an Isa, or switching all or part of the loan to a repayment mortgage. Selling the endowment policy is by no means the only, or best option.

"Making a snap judgement to get rid of the endowment is not always the best idea," cautions David Hollingworth, director at mortgage brokers London & Country. "There are still home owners who feel that the endowment and the mortgage are wrapped together and they cannot change one without the other. You can, for example, keep the endowment going, and switch part of the mortgage to repayment."

He suggests that home owners with a projected shortfall should also look at the underlying interest rate they are paying on their mortgage: it might be possible to switch to a cheaper deal, move to a repayment mortgage and still save money.

But the important point is to act, as the longer the home owner delays, the harder it will be to make up the shortfall. And, if you do win compensation, put the money towards paying off the mortgage. Unless you are sure you have other arrangements in place to cover the shortfall, treating any mis-selling payout as a windfall is risky indeed.

www.fsa.gov.uk/consumer/01_ WARNINGS/endowments/mn_endowment.html