Endowment mortgage policies were sold primarily in the 1980s and 1990s as an alternative option to a repayment mortgage. An endowment mortgage is a type of insurance savings policy which is designed to grow over a certain time scale (often 25 years) to pay off the amount borrowed to purchase of property. The homeowner usually pays interest on the mortgage and a monthly premium into the endowment mortgage savings plan.
They are basically two types of endowment mortgage policy. A full endowment mortgage policy is where there is an underlying guarantee that all of the mortgage amount will be paid off. In paying for this guarantee the monthly premiums are expensive which explains why the second type of endowment mortgage, the low cost endowment mortgage has been by far the most popular plan sold to millions of U.K. householders over the last twenty years.
Both full and low cost endowment mortgage policies are linked to the stock market. The problem with low cost endowment mortgages is that they do not guarantee to pay off the mortgage at policy maturity and they are dependent on positive stock market returns to ensure that they do.
The majority of endowment mortgage policies taken out in the 1980s were with profit plans linked in directly to the stock market. A with profit low cost endowment mortgage consists of an underlying guarantee called the Basic Sum Assured upon which the insurance company will pay annual bonuses dependent on the profits made by the insurance company through its with profit fund. This with profit fund is invested in stocks and shares - however, the fund is managed to provide a smoothed return so that investors are protected from stock market volatility.
To do this the with profit fund will keep back some of the profits during strong performing years to compensate investors in years where the returns may be poor. It is the combination of the Basic Sum Assured and the bonuses accrued over the life of the endowment mortgage policy that in theory will add up to the sum required to pay off the mortgage. Over the last five years we have seen a dramatic falls in with profit fund bonuses as global stock markets have declined in value, so much so that many insurance companies can no longer provide endowment mortgage policyholders the assurance that the final maturity payouts will cover their mortgage.
In the late 1980s, insurance companies introduced unitised endowment mortgage policies as an alternative to with profits. These types of policies are directly linked to the stock market and therefore are more prone to fluctuation in value as there is a direct correlation with general stock market performance. As a result these policies have been hard hit by a stock market force in the last few years.
