Endowments feel the pinch

Last month Coventry Building Society, the country's 13th largest, announced it would no longer be selling endowment mortgages, writes Paul Slade.

This was less of a criticism of the endowment vehicle itself than a strategic decision by the society. It decided to drop its tie-up with insurer Commercial Union to concentrate on core building society business such as savings accounts and repayment-style mortgage loans. Nevertheless it came as one more blow to the endowment mortgage, which has come under increasingly heavy criticism.

Figures from the Building Societies Association show that endowment-based mortgage loans have become less popular,dropping from 80 per cent of new loans in 1987 to 60 per cent in 1994. Repayment loans have grown from 18 per cent to 25 per cent. Other types of mortgage, including those which are PEP-based, now account for 15 per cent of the market.

With an endowment mortgage, your monthly payments are effectively split into three parts. The first pays off the interest, the second pays for life insurance to ensure the lender gets his money back if you die, and the third is invested in a stockmarket-linked savings plan to build up a sufficient capital sum to pay off your mortgage at the end of its term. The endowment policy is these second and third parts.

PEP mortgages work in a similar way in that part of your monthly payment goes towards the interest on the mortgage loan, while the remainder is paid into a PEP to grow tax-free and produce a lump sum to pay off the loan later. In addition, the lender may require the borrower to buy a life insurance policy to make sure the mortgage is repaid if the borrower dies before the end of the loan term.

By comparison, with a repayment mortgage each monthly payment covers the interest on your loan as well as repaying a small part of the capital. Again, the lender usually requires the borrower to buy life insurance.

With endowments, insurance companies can use any figure from 5 per cent to 10 per cent when making its investment growth assumptions. If the policy fails to keep pace with your insurer's assumptions, you may be forced to increase your payments. Poor investment performance in the early 1990s has resulted in thousands of borrowers being warned that their endowments are unlikely to pay off their mortgages. In the past few weeks, Pearl, Britannia and Eagle Star have advised policyholders to increase their premiums or - in the case of Pearl - save in a society account.

The charging structure of endowments is a further problem. Most of the fees for setting up and selling an endowment are subtracted from the investor's premiums in the first few years of the policy. In many cases, all of the investor's money will be mopped up by charges in the first two years. This makes it expensive to cash in. Borrowers who think they are unlikely to continue paying into an endowment for its full term would be advised to steer clear.

Keith Railton of Coventry building society says that his society's decision to stop selling endowments had more to do with the regulatory- induced costs of selling policies than worries about the product itself. But he adds: "I think the repayment mortgage is, for some people, an easier way of getting a mortgage."