In this brief blog, we are going to discuss what an endowment mortgage is and why they failed.

What is an endowment mortgage?

An endowment mortgage is a mortgage which has an interest-only repayment term and the balance is paid off by an endowment policy which is attached to the mortgage.

The phrase “endowment mortgage” is used mainly in the United Kingdom by lenders and consumers to refer to this arrangement and is not a legal term.

An endowment mortgage is seen as a low-cost mortgage which allows you to make monthly mortgage repayments which are much smaller than if you were to get a capital repayment mortgage.

An endowment mortgage is similar to an interest-only mortgage where you repay the balance at the end of the mortgage term and only make monthly mortgage repayments which contain just the interest.

The endowment mortgage and the endowment policy which is attached to the mortgage are actually two separate things and can both be modified independently. The mortgage lenders will usually have insisted on getting an endowment policy in order to further secure an interest-only mortgage and ensure there was a suitable capital repayment vehicle. 

The mortgage lender used a legal device to ensure that the proceeds gained from the endowment mortgage were paid to them at the end of the mortgage term rather than being paid to the borrower.

The endowment policy was typically assigned to the lender rather than the borrower.

Endowment mortgages are now very rare.

What is an endowment policy?

An endowment policy is a life insurance policy which pays a fixed amount after a certain term or on the death of the policyholder. This could be 10 years or 15 years or in certain cases maturity could be up to a certain age limit of the borrower. Some endowment policies will also payout based on critical illness.

In the past, endowment mortgages were linked to interest-only mortgages.

Endowment policies were typically traditional with-profits or unit-linked.

You can either have a:

Unit linked endowment

Full endowment

Low-cost endowment

Traded endowments

Why did people get endowment mortgages?

Endowment mortgages were seen as favourable as they had low monthly mortgage repayments as you only had to repay the interest charged on the balance outstanding each month. This meant most people could reduce their initial costs and use endowment mortgages as a good choice when investing in property.

An endowment mortgage was also seen as a good option as the endowment policy attached to the mortgage would be used to pay off the mortgage at the end of the mortgage term and hence most borrowers found endowment mortgages as low risk.

Another positive of the endowment mortgage we found on the internet states “An additional reason in favour of an endowment was that many lenders charge interest on an annual basis. This meant that any capital repaid on a monthly basis is not removed from the outstanding loan until the end of the year thus increasing the real rate of interest charged. In such a situation, payments into an endowment might benefit from any growth from the moment it is invested. Henceforth, the net investment return required for the endowment to pay the loan would be less than the average mortgage interest rate over the same period.  “

The drawbacks of endowment mortgages

In a case the endowment policy did not perform as anticipated then the borrower will find that they have an outstanding balance to pay to the mortgage lender after the endowment policy has paid out. This meant a lot of borrowers had to sell their properties in order to repay the shortfall from their endowment policy or dip into their savings in order to pay the shortfall.

Endowment mortgages have no capital repayment and so the interest being charged on the capital owed stays constant throughout the lifetime of the mortgage.

How does an endowment mortgage work?

An endowment mortgage works by allowing you to only make interest repayments in your monthly mortgage repayments. It means you have to pay the balance at the end of the mortgage term. You do this with an endowment policy which is attached to the mortgage. You have to pay a premium for this endowment policy.

Can you still claim for endowment mortgages?

You can claim for endowment mortgages within 6 years of being sold the endowment mortgage or within 3 years of knowing you could make a claim. This could be if you have received a red warning letter stating that you have been mis-sold the mortgage and let you know when the deadline for making a complaint is. You can only complain if the endowment policy has been mis-sold not if it doesn’t perform well.

Why did endowment mortgages fail?

Endowment mortgages failed as the insurers overestimated the returns on the endowment policies which led borrowers to take mortgages which they would not be able to repay with the endowment policy. This caused a lot of debt and subsequently, insurers and mortgage lenders had to compensate the mortgage borrowers for misselling the product.

What to do if your endowment policy won’t pay off your mortgage?

If your endowment policy won’t pay off your mortgage then you have a few options.

If you feel you have not been mis-sold the mortgage then you should look for a way to come up with the shortfall. This could be by borrowing from family members, taking on a new affordable loan or by selling your assets such as the property.

If you think the endowment mortgage was mis-sold then you have a few options. You can complain within six years from when you were sold the property or within three years from the date in which you became aware that you have grounds to complain.

“Being aware that you had grounds for complaint”  would come into effect if your endowment provider has sent you what is known as a red-letter warning you that there is a high risk of the endowment policy failing to meet the target payout.

Once you have received this letter you will also have been made aware of the final date for making a mis-selling complaint. Once this final date has passed, the firm which sold you the endowment doesn’t have to consider your complaint and you lose the right to take it to the Financial Ombudsman Service.

“Even if you still have time to make a complaint, there is no point if your complaint is mere that the policy hasn’t done as well as you had hoped it would. You need to be able to show that the policy was mis-sold.

You would have grounds for making a mis-selling complaint if, for example, the adviser told you that the policy would definitely pay off the mortgage, or did not explain that it might not meet the target amount or that other options for repaying the mortgage, such as taking out a repayment mortgage, were not discussed.

You may be able to claim if any of the below matches you:

“Not receiving a full explanation that there could be a shortfall at the end of the mortgage term

Being told that the endowment would definitely pay off the mortgage

The fees and charges were not explained

An adviser did not complete an assessment of finances and attitude to risk

Sales staff failing to ensure that income was available if the policy ran into retirement years

Receiving advice to cash in an endowment and being sold another   “

You can take your claim to the financial ombudsman.

If you are able to make a valid complaint, it is worth doing since you should receive compensation which essentially puts you in the financial position you would be had you taken out a repayment mortgage instead of an interest-only loan linked to an endowment.”

The use of endowment policies to repay a mortgage is now rarely heard of. This is because the financial regulators were able to prove that the potential returns which insurance providers were stating were in fact exaggerated and the risks of an endowment mortgage were not carefully explained to the borrower. This led them to go on and take mortgage products which they will eventually not be able to pay off.

The regulator instructed that revised projection letters were issued to all borrowers with outstanding endowment mortgages and this saw a lot of projected returns revised to the point at which it was obvious that most endowment mortgages will not be paid off.

A lot of borrowers filed complaints about the projections they initially received and claimed they were mis-sold the mortgage product

As a result, a lot of insurers and mortgage lenders were forced to compensate for the borrowers.

As of July 2006, UK banks and insurance providers have paid out approximately £2.2 billion in compensation.

In this brief guide, we defined what an Endowment mortgage is. If you have any questions or comments please let us know.

John Bate

John has 22 years of experience in financial services. This spans across financial research, financial services (As a qualified mortgage broker and underwriter), financial trading and sales at global investment banks. While working as a publishing research analyst, he covered European bank credit and advised institutional clients on investment strategies at both JP Morgan and Societe Generale. John has passed all three levels of the CFA (Chartered Financial Analyst) programme.