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FOOL'S EYE VIEW
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A powerful all-party group of MPs, the Treasury Select Committee, today released a damning report on the widespread mis-selling of mortgage endowments. (These MPs are really getting their teeth into financial services companies; they savaged credit and store card issuers last December!) MPs revealed that four out of five endowments (80%) will mature with values short of what is needed to pay off the associated mortgages. The average shortfall for failing policies is predicted to be around £5,500 each. What's more, MPs reckon that a staggering three out of five policies (60%) have been mis-sold. With an estimated 8½ million policies in force, homeowners are going to have to find an extra £37 billion to pay off their home loans. Indeed, about 4½ million homeowners are relying on endowment policies to clear their entire mortgage debt. (The scale of the problem could be much worse: some estimates suggest that there may be as many as eleven million policies currently in force.) MPs were particularly concerned about people on low incomes and those with very large shortfalls, whom they describe as being in an "advice vacuum". Some may be forced to sell their homes, or continue working well past their normal retirement date. Hence, the Treasury Select Committee has called for better financial advice for policyholders with shortfalls, plus it wants to extend the current time limits for mis-selling complaints. Essentially, there are two main reasons why endowments are failing to live up to their billing. The first is their amazingly high charges, which have decreased their returns. Endowments paid very high upfront commission to salespeople, which meant that investors would not receive positive investment returns for the first few years of their policy. The second reason why the performance of endowments has been lousy in recent years is the collapse of the stock market between 2000 and 2003. After peaking at 6,930 at the end of 1999, the blue-chip FTSE 100 index (which measures the value of the UK's one hundred largest listed companies) fell by over 50% in the next three and a bit years. Given that the funds that endowment premiums go into were largely invested in shares, their performance has suffered in this bear market. Endowments were hugely popular from the late Seventies to the early Nineties, with sales peaking in 1988, right at the climax of the previous housing bubble. At that time, around five out of six mortgages (83%) came with an endowment attached! Given that most endowments have a term of 25 years, endowment heartbreak should reach its peak in about nine years' time, in 2013. These days, borrowers steer well clear of endowments: only around 1 in 20 new mortgages (5%) have one sold alongside them, so this problem will have largely gone away by about 2025 or so! Despite this looming catastrophe, only around 1 in 16 policyholders (6%) has made a formal mis-selling complaint and received compensation, which has totalled £670 million to date. So, here are a few approaches to confronting your endowment shortfall: The safest option: start paying off your home loan now Interest rates have tumbled in recent years, which means that monthly repayments on home loans have fallen. If you have an interest-only loan and an endowment shortfall, it makes sense to pay extra monthly or one-off contributions to reduce your debt. Because the interest rates charged by mortgages are usually higher than those paid by savings accounts (especially taxed accounts), it can make sense to use some of your existing savings to pay down your home loan – but don't leave yourself short of emergency money. Before jacking up your repayments or throwing in a lump sum, check with your lender to make sure that you won't be penalised for doing so. Also, if you are one of the millions of borrowers with an old-style 'annual interest' mortgage, your repayments won't be knocked off until your mortgage anniversary. Therefore, you should only pay in extra money a couple of weeks prior to the anniversary date (usually 31 December, but do check). The cash option: save in a cash mini-ISA If you can't hike your mortgage repayments, perhaps because you're in a special-rate deal that comes with fines ('redemption penalties') attached, you could consider saving up enough to meet your shortfall in a tax-free cash mini-ISA. For policyholders whose endowments are maturing within the next ten years and who don't want to take a gamble on the stock market, cash is the sensible option. Saving £82 a month for five years in a tax-free account earning 4.5% interest would produce a lump sum of £5,514 – enough to wipe out the typical endowment shortfall. Warning: You still have time to open a cash mini-ISA for this tax year (2003/04), into which you can deposit a maximum of £3,000 by 5 April. Here are the contribution limits for the coming three tax years: 2003/04, 2004/05 and 2005/06 tax years = £3,000; from 2006/07 onwards = slashed to a measly £1,000. Boo! So, if you don't have a cash mini-ISA (or a maxi-ISA) for this tax year, you can squirrel away up to £9,000 between now and 5 April 2006 and earn tax-free interest on the lot. As with all saving, the early you start the better, so don't hang about! The riskier option: invest in a shares ISA If you have at the very least five years before your endowment matures, and preferably ten, you might want to take a risk and invest in the stock market. However, if you've learned anything from your endowment mishap, you should be avoiding products with high charges! One cheap, simple and flexible way to harness stock-market growth is to invest in an index tracker. What's more, by putting a tax-free ISA wrapper around your index tracker, you can keep the taxman's greedy paws off your lolly. Another low-cost investment is an Exchange Traded Fund, which is a little more complicated but is worth considering. Here's our most recent article on these little beauties. The alternative option: make a mis-selling complaint If the salesperson who sold you an endowment misled you during his/her sales pitch, you may be entitled to make a formal mis-selling complaint. For example, s/he may have: Endowment Action, a site created by the Consumers' Association, publishers of Which? magazine, will help you to find out whether you have a valid complaint, and explains how to submit one. Three things to avoid: the DON'TS! Here are few more articles on endowment shortfalls: The author owns shares in Legal & General (and has a poorly performing with-profits endowment with Standard Life – never again!).