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The early birds are cashing in

Paying off a mortgage early is becoming one of the major reasons why people cash in their endowment policy before the end of the term.

There is a substantial opportunity for IFAs to advise them of their options when it comes to cashing in their endowment.

Nowadays, just 30 per cent of endowments sold relate to the purchase of a house. However, in the late 1980s, a huge 80 per cent of endowments sold were related to mortgages. This means that a large number of people with 10 or less years to run on their mortgage are likely to be using an endowment as their repayment vehicle. This is reflected in the number of people cashing in their endowment to pay off their mortgage.

Absolute Assigned Policies&#39 statistics show that 14 per cent of people choose to sell their endowment because they are repaying their mortgage early and a further 16 per cent because they are remortgaging. These people tend to be aged between 35-45 with seven or eight more years to run on their policy.

IFAs can play a major part in helping clients understand the options open to them both for paying off an interest-only loan or remortgaging their property.

Interest-only mortgages work by the borrower paying just the interest with each mortgage payment. When the borrower takes out the mortgage, they usually also take out a repayment vehicle, such as an endowment policy, pension or Pep/Isa. This policy is designed to grow throughout the term of the mortgage period into a sum sufficient to pay off their capital debt at the end of the term.

Back in the late 1980s, when thousands of homeowners took out these policies, the hope was that, having paid off the capital, the borrower would be left with an extra lump sum. This would be achieved through the investment performance of the endowment policy, annual bonuses from the policy provider plus a terminal bonus at the end of the policy term.

As there is no other repayment vehicle, this means the policyholder is dep-endent on the performance of the investment vehicle to pay off their mortgage.

When people near the end of their mortgage term, most prefer to pay off the loan if they can afford it. This decision is often based on the fact that they have come into some money, either through inheritance, bonuses from work or another source.

Historically, people who took out mortgages in the late 1980s had to borrow large amounts of money because of high house prices. Rather than have a big loan hanging over their heads, most people prefer to pay off the loan as soon as possible. Remortgaging is also on the rise. The Council of Mortgage Lenders expects that refinancing will remain popular during 2001 and expects it to account for nearly 30 per cent of total lending.

The reasons for remortgaging are more complicated. The borrower could simply be moving house but the reasons behind this could be a divorce or redundancy.

It is also clear that more and more people are taking control of their mortgage arrangements. Recent figures from the CML show that over 43 per cent of borrowers have made some change to their mortgage – including remortgaging to a new lender – and 16 per cent of borrowers now have flexible mortgages.

Despite the bad publicity that has been heaped on with-profits endowment policies over the past year, it is rarely in the client&#39s interest to cash in their policy early. This is because endowments include various up-front charges and the policy will not have had time to mature as it was designed to do.

Most market-makers – the purchasers of unwanted endowment policies – will not buy a policy unless it has been in force for at least seven years and has a minimum value of £1,000. Despite a general downward trend in annual bonuses, endowments maturing now still deliver an average return of around 12 per cent. This is favourable compared with a number of other equity-linked investment vehicles.

The number of people flocking to invest in secondhand endowment policies, either through a private portfolio or a Tep fund, is further evidence that they are still regarded by many as valuable investments.

When a client is at a point when they want to cash in their endowment, IFAs should be aware that it is much better for them to approach a market-maker rather than surrender the policy back to the provider.

Market-makers can offer up to 35 per cent more for an average policy of £10,000, depending on how long the policy has been in force. Broker commission for recommending clients to marketmakers is typically around £360 for customers selling endowment policies with a surrender value of £10,000.

As more people who bought property in the boom of the 1980s near the end of their mortgage term or decide to try out another type of loan, there will be many who seek advice from IFAs on what to do next. While cashing in their endowment in the early years may not be good advice, when they come to sell the policy, they will get a much better valuation from a market-maker than their original provider.

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