Endowment mortgage

An endowment mortgage is a mortgage loan arranged on an interest-only basis where the capital is intended to be repaid by one or more (usually Low-Cost) endowment policies. 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.

The borrower has two separate agreements. One with the lender for the mortgage and one with the insurer for the endowment policy. The arrangements are distinct and the borrower can change either arrangement if they wish. In the past the endowment policy was often taken as an additional security by the lender. That is, the lender applied a legal device to ensure the proceeds of the endowment were made payable to them rather than the borrower; typically the policy is assigned to the lender. This practice is uncommon now.

The customer pays only the interest on the capital borrowed, thus reducing the monthly payments in comparison with an ordinary repayment loan; the borrower also pays premiums into an endowment life-assurance policy. The intention is that the payout from the endowment policy when it matures will be sufficient to repay the mortgage at the end of the term, and possibly create a cash surplus.

Up to 1984 qualifying insurance contracts (including endowment policies) received tax relief on the premiums known as LAPR (Life Assurance Premium Relief). This gave a tax advantage for endowment mortgages over repayment. Similarly MIRAS (Mortgage Interest Relief At Source) made having a larger mortgage advantageous as the MIRAS relief reduced as a repayment mortgage was repaid. This tax incentivisation toward endowment mortgages is not often commented on in the media when they discuss endowment mortgages.

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.

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