Endownment Mortgage shortfall not as bad as it first appear, if you act now!

May 8th, 2013 - Posted by in Blog


Today’s big financial news is the looming time-bomb for interest-only mortgage holders. Below is a quick summary of the problem:

“Some 2.6 million UK householders have the mortgages but the Financial Conduct Authority said estimates suggested that nearly half would not have savings or other funds to cover the final bill. The average shortfall is £71,000, according to FCA research.” The FCA is new name for the Financial Services Authority.

At first glace, this is a massive and scary problem and the end result could cost hundreds of thousands of people having to either sell their house or having to take out a new 25 years mortgage to pay off the mortgage they have already been paying for 25 years, crazy right? Yes, but for the vast majority that won’t happen and for others if you act now you can stop a lot of pain in the future.

What is an endowment mortgage?

There are basically there types of mortgages:

  1. A repayment mortgage – A normal loan, e.g. each month you payback part of the total amount plus interest.
  2. An interest-only mortgage – You only pay-off the interest part, none of the capital is paid back. So at the end end of the term the orginal amount is still left to pay, e.g if you took out a 25 year interest-only mortgage on £150,000 you would still have £150,000 to pay back at the end of the 25 years.
  3. An endownment mortgage – An interest-only mortgage, but to be able to repay to capital at the end of the term, a separate endowment policy is arranged. Basically an endowment policy is an investment. The idea is that investment grows over the mortgage to be big enough to cover the repayment at the end.

Why there’s going to be a shortfall

The reason people take out an endowment mortgage is because it should be cheaper than a repayment mortgage. In a rising market, the money you invest will grow to cover your house, but it’s a gamble. As we all should know, investments can go up, down or remain flat. The whole world has been gone through a massive financial crisis and therefore the majority of the endownment policies won’t grow big enough to cover the cost of the house.

Why the problem is not as big as it first sounds

Firstly, the numbers are smaller than they first sound, so don’t get too alarmed – yet

  • 2,600,000 have endowment mortgages due to mature in the next 30 years
  • Of which 50% are forecasted not to have enough to cover the full capital cost of their home – that’s 1,300,000
  • 600,000 are classed as the “most pressing cases” – with loans maturing between now and 2020.
  • 100,000 which face a shortfall of £50,000 between now and 2020.

So of the 2.6m, 100k have a shortfall of £50,000 and have up to 17 years to repay that. Which means the vast majority have 17 years or more to repay amounts ranging from a few thousand to £50,000.

What do if you have an endowment policy

It must be sickening to think you might have to find thousands and thousands to pay off your house, after paying into a mortgage for up to 25 years, but there is a some good news. Firstly, for those 25 years you’ve probably been paying less than someone with a repayment mortgage and therefore you’ve been feeling the benefit of that for years. Also, the chances are, you’ve years until your mortgage ends and the capital is required, this gives you a lot of time to save and plan. If your mortgage lender said to you today, “You need to give me £25000, otherwise you need to sell your house,” very few people could pay. But if you have 10 years to plan, that would mean putting £50 a week into a savings account or taking out a 10 year mortgage, not nice, but certainly a lot more achievable. Plus, you if you put the money in a bank you get the benefit of compound interest.

Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn’t … pays it.” Albert Einstein

Finally, mortgage rates are extremely low. In fact, interest rates aren’t just low, they’re 1.5% below the prior lowest in its 316 year history!

What action to take to deal with a short-fall:

  1. Find out your situation – Is your endowment currently forecasted to pay off your house or not? When is capital due? Even if your endowment is forecasted to cover your capital, I would still plan for a short-fall because your investment could decline even more. 
  2. Make a plan to pay off the short-fall – Once you know what the shortfall will be and when the money is due, you can make a plan to get the money from elsewhere.
  3. Start the plan today! (or asap) – The sooner you act, the easier it will be in the long-term.

How to find the missing money

Let’s say, in 10 years, the forecasted shortfall will be £25,000. Firstly, lets add 10% onto that as a contingency, giving us a target of £27,500 in ten years. Below are few ways to pay this off, and you can use a combinations of these ideas:

  1. Saving cash in a bank – This is the safest way, plus you get the benefit of compound interest. Simply divide the total required by the number of months until the repayment is due, e.g. 10 years x 12 months = 120 months. £27,500 divided by 120 months = £229.17. But due to compound interest you won’t need that much, based on interest of 2.6% from Virgin Money. You would need to put £203 into the savings account each month, I used this compound interest calculator. It might be still a lot of money to find but remember two things, a) there are always more ways to save, here are about 50 ideas that could save you thousands each year, b) you’ve been underpaying on your house, so don’t think of it as needing to find extra money, but instead as you’re repaying the true cost of your house. I would set-up a standard order from your current account to a high interest bank account, to ensure that money is saved every month without fail.
  2. Take out a second mortgage now – Mortgage rates are at an all time low, so now is a good time to take out a fixed repayment mortgage for the short-fall. You should be able to fix the interest for the whole term so there is no nasty shocks in the future.
  3. Sell your house at the end and downsize – At the end of your mortgage term you might have been planning to retire, at which point, lots of people downsize because the kids have flown the nest and you don’t need such a large house to maintain. You might be able to sell your house, pay off the short-fall and still afford to buy a smaller property outright. But you need to investigate this, there are certainly no guarantees.
  4. Downsize now / move to a cheaper area – the reason you were advised to take out an endowment mortgage was probably because you couldn’t afford a repayment mortgage. Now that it’s becoming clear that the endowment won’t cover you, why not consider moving to cheaper house on which you can afford a repayment mortgage. It’s not a nice thought, but by moving to cheaper area you can save tens of thounsands of pounds.
  5. Take a new repayment mortgage at the end of the term – If you are young enough (typically under 65 years old at end of your current term, but up to 75 years with some lenders), you could take a new mortgage.
  6. Win the lottery – Unfortunately, this will be the repyment strategy for some. Bury their heads in the sand and hope a miracle will happen. Good luck on that one.

It’s a horrible situation to be in, I do feel for you. But with a bit of planning, saving and hard work, you can overcome this problem. Good luck.

What other ways would you add to this list of strategies to protect from a short-fall? I and the Happier community would love to read your comments, please add below.

  • http://www.themoneyprinciple.co.uk maria@moneyprinciple

    Julian, a great piece. I have been getting a bit fed up with the scare campaign that seems to be on the cards. Great advice as well. The only point where I’ll disagree slightly is about staching cash in the bank – most interest is really pittiful at present (Natwest recently lowered there interest on ISAs to well below 2%). We have been looking at flexible investment platforms like Nutmeg and Rplan.

  • Julian Hearn

    Hi Maria,

    Thank you for the kind words. Yes banks do offer extremely poor rates at the moment compared to historical rates. You are probably right that alternative investments should be considered, but my only slight argument is that most people won’t have to repay their endowments for 10 years+. The likelihood is that bank interest rates will increase over that time, plus you will also benefit from compound interest and banks are still the safest and easiest place to invest money for the majority of people.

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