The Gazette 1988

SEPTEMBER 1988

GAZETTE

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.

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. 215

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: