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GAZETTE
SEPTEMBER 1988
Housing Finance
Up to relatively recently questions w i t h regard to the " b e s t " home
loan were o f t en of academic interest. With mortgage finance in
short supply f ew people had the luxury of choice. The cost of the
mortgage came second to the problem of getting it. Many people
were, or would have been, willing to pay a little extra interest simply
t o get a loan, but even that choice was not always open since most
of the building societies charged the same rate in any case. All that
has changed — changed dramatically. The borrower can now shop
around — lenders are vying w i t h one another for the business -
and in addition to a choice of lender, the borrower has also a choice
of loan type, most particularly between the traditional " annu i t y"
mortgage and the " endowmen t" type mortgage. The market for
mortgages has become a buyer's one.
The would-be borrower has now
a lot of choices to make and
unfortunately there are no definitive
an swe r s. At p r esent bu i l d i ng
society loans are cheaper than
bank loans but will that continue to
be the case for the full t wen ty
years or so over wh i ch the loan is
being repaid? The answer is
possibly " y e s ", but it is impossible
to be sure. Will an endowment
mortgage work out better than the
traditional type. The answer is
possibly " y e s ", if the borrower is
paying reasonably high tax and
picks the endowment insurance
policy w i th care. But again, it is
i mp o s s i b le to be sure. The
endowment policy may not perform
well, there could be a change in the
current tax relief situation.
The best that can be done is to
take an educated guess on the
basis of the present situation and
likely trends in the medium term.
That wou ld seem to point to
bu i l d i ng soc i e t i es rather t han
bank s.
W i t h
less
c e r t a i n ty
endowment mortgages are likely to
prove a better bet for people paying
tax at above the standard rate. But
it is important to choose the
endowment policy w i th care.
Let us have a look at the reasons
for those conclusions in some more
detail.
The accompanying table shows
the declared interest rates, and,
more importantly, the repayment
rates currently applied by the big-
four banks and main building
societies. It will be noted that the
dec l a r ed i n t e r est rate is not
necessarily a good guide to the
actual cost of the loan. The new
law requiring lenders to declare
comparable Annual Percentage
Rates (APRs) is still not fully
ope r a t i onal w i t h t he bu i l d i ng
societies still disputing what should
be included.
Before looking at the initial banks
and building societies let us have a
By
C o l m Rapp le
look at the broad choice between
t he
t r a d i t i o n al
" a n n u i t y "
r e p a yme nt me t h od and t he
endowment mortgage. With the
t r a d i t i o n al
mo r t g a g es
ea ch
repayment includes t wo elements
- an interest payment and a
payment off the sum borrowed. So
the amount owing progressively
reduces over the term of the loan.
With an endowment mortgage only
the interest is paid off the loan but
in addition premiums are paid on an
e n d o wm e n t i n s u r a n ce po l i cy
geared to yield enough at some
time in the future to pay off the
loan.
With the endowment mortgage
the borrower can get tax relief on
the interest payments and on half
of the premiums and it should
remain unchanged for the term of
the loan - assuming no changes
in interest rates or in the law. Wi th
an annuity mortgage the tax relief
goes d own as the interest portion
of repayments reduce but that
reduction is not significant during
the first ten years or so of a t wen ty
year loan.
But there are some points to
watch:
Many endowment loans are
sold on the basis that the policy
will not only yield enough to pay
off the loan but can also provide
a surplus lump sum. So they
can. But if the borrower also
wants to save, it is best done
sepa r a t e l y. The re is less
flexibility when savings are tied
in to the mortgage repayments
The performance of endow-
ment policies can differ greatly.
There is no guarantee that the
proceeds will be enough to pay
off the loan but the " w i t h
profits" policies most commonly
used are relatively risk free in
that they can not collapse in
value and bonuses once added
in are usually secured. The unit
linked policies used in some
cases do promise a chance of
higher returns but they are also
vulnerable to a down t u rn in
value - another crash?
All the borrower needs is a
policy wh i ch will pay off the
loan. He or she should not be
influenced by thoughts of extra
l ump s ums. Any
s a v i ngs
decisions are best kept separate.
While unit linked policies offer
the prospect of higher returns
they are riskier than straight
forward endowment policies. Of
the endowment policies the best
performers have been " w i t h
profits" policies of the British
mutual societies - companies
like Standard Life. No r w i ch
Union and Friends' Provident.
Tax relief on life insurance is
allowed at 50% of the premiums
subject to a maximum of £1,000
premiums per individual. If a
person has already got some life
insurance, or is taking out a large
loan, it not too difficult to go
over that limit.
So let us have a look at who is
offering wha t:
BIG FOUR BANKS
All the banks are now very actively
promoting home loans.
All but the Bank of Ireland
charge an initial arrangement fee of
V/2% of wh i ch 1% is returned
when the security is perfected.
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