An Endownment Mortgage
A popular form of loan in the United Kingdom, an endowment mortgage is virtually non-existent elsewhere. It involves the borrower making monthly payments toward the interest and an endowment premium. An endowment mortgage has various disadvantages, making it uncommon in other parts of the world. Even in the U.K., the popularity of endowment mortgages has declined.
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Features
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With an endowment mortgage, the borrower takes out a lump sum loan for a property purchase and makes monthly payments to pay off the loan. The monthly payments consist of two parts: interest and endowment premium. The lender keeps the interest payment and invests the endowment premium in the financial markets. The aim is to build the total value of the investment so it can cover the original loan amount by the end of the mortgage term. The endowment premium also includes life insurance, which pays off the mortgage to the lender if the borrower dies.
Benefits
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Endowment mortgages became popular in the early 1980s in the U.K. At that time, inflation and interest rates were high. Borrowers also received tax relief on endowment premiums. Because of the high inflation and interest rates, there was a high probability the invested endowment premiums would grow to an amount that was larger than the mortgage loan amount. The loan would be paid off from these funds, and the borrower would be paid the extra money at the end of the mortgage period.
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Shortfall
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When interest rates and inflation rates fall, invested endowment premiums don't enjoy the expected growth rate. The endowments may not grow large enough to repay the original loan amount. This condition, known as a shortfall, affects hundreds of thousands of people, according to thisismoney.co.uk. In this case, the lender may request that the borrower make larger monthly payments toward the endowment, so the final amount will be enough to pay off the loan.
Other Drawbacks
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With a regular mortgage, the monthly payments go toward the interest and reducing the original loan amount. With an endowment mortgage, the outstanding amount of the mortgage loan remains the same over the life of the mortgage. Because the lender calculates the interest payment based on the outstanding balance, the borrower of an endowment mortgage pays more in interest. In the past, the tax relief could help make up for the difference, but, the U.K. government no longer offers tax relief on endowment premiums.
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