This is the most common type of investment with an interest only mortgage. You pay a fixed monthly payment towards an investment which is designed to grow so that the amount invested and it’s growth are enough to pay off the capital on the mortgage at maturity. This policy will also provide life assurance, so your mortgage will be paid should you die during the term of the plan.

At the beginning of the policy, assumptions will be made about the growth of your investment. The problems with endowments have arisen when people have signed up to a very high growth rate, which has then not been achieved over the life of the policy. This has meant that their monthly investment has not generated enough capital to fully repay the loan at the end of the term. Your investment will be more secure if you work on a cautious growth assumption. This will require higher monthly payments, but will be less risky.

If the plan has performed well, then you could end up with a lump sum payment in excess of your capital repayment at maturity. This cash surplus is tax free. However if the policy has not performed well, you may have to find funds to pay a portion of the capital yourself.

There are several different types of endowment policy:

Full with-profit endowment

This is the most expensive type of plan. It guarantees an annual growth rate and to pay off the loan in full at maturity. Your monthly investment premium will be pooled with the premiums of other investors and paid into a fund which is managed by the company. Each year a bonus is added, depending on the performance of the fund. A final bonus will be paid at the end of the life of the plan – this may represent a large portion of the capital repayment and is guaranteed to repay the loan. The large final bonus means that you will probably not be able to pay off your loan early.

Low cost endowment

This works in the same way as the full with-profit plan, but without the guarantee of paying off your loan in full at maturity. The growth assumption rate is used to determine your monthly payment. This will be lower than for a full with-profit plan as you are not paying for the guarantee. If profits are less than the initial growth assumption, you would have to find the funds to cover the shortfall. However you will be warned during the term of the policy if your plan looks as though it may have a shortfall and you can increase your monthly payment.

Unit linked endowment

Your monthly premium is used to buy units in a managed fund. The more monthly premiums are paid, the more units you hold. This method does not pay any bonuses, so if your fund has grown to a level whereby you can pay off your capital loan, you can cash in your policy. The total amount of money your policy is worth will fluctuate depending on the performance of your units so provided your assumed growth rate is maintained or exceeded, you will be able to pay off your loan in full. The opposite is also true and if the growth is lower than assumed you may have to adjust your payments to achieve the full capital repayment.

Unitised with profit endowment

With this policy, the value of the units is declared annually and this value is then guaranteed. This is designed to smooth out the price fluctuations of a standard unit linked policy. The guaranteed value is less than the actual value, so the chance of paying off your loan early is less, but so is the risk involved. This is an attractive policy when markets are volatile.

Low start endowment

This is designed for the expensive first few years of property ownership. It follows the same route as the low cost endowment, but premiums begin low and increase over a number of years. The overall amount that you pay into this type of plan will be higher than with a standard low cost endowment and the cash-in value will be lower for longer.

Non profit endowment

There are no bonuses paid with this type of policy, so you will not have a cash surplus on maturity. You will pay your monthly premium and this will be invested to cover the cost of your capital loan on maturity.

Advantages

If you choose a policy with a cautious growth assumption then you should have a tax free cash surplus on maturity of the policy.

If you choose a policy which can be paid back early, you can clear the mortgage completely as soon as the capital repayment value has been reached.

Life insurance is included in the policy so you do not need to arrange this separately. This gives peace of mind that the mortgage will be cleared in the event of your death.

If one payment covers your interest and monthly premium, then the amount of money invested will be higher during periods of low interest rates. This is because less of the fixed payment is needed to pay your interest charges, so more can be invested, increasing your likelihood of a cash surplus.

Policies can easily move with you. If you need to borrow more money for a more expensive property, you can simply adjust your monthly payment to cover this. This can be done without extending the term of your mortgage, so can be paid off faster than with a series of repayment mortgages.

Disadvantages

If growth does not occur in line with your growth assumptions, you may end up with a shortfall which must be paid to the mortgage lender immediately on maturity of your policy.

The size and performance of your fund depends on the ability of your insurance company to invest wisely.

If you pay one fixed monthly payment to cover the interest and policy, then the amount being invested in your policy may be low during periods of high interest rates. This can affect the final maturity payout.

It is difficult to cash in a policy. The insurance company can charge highly and you get back less than you have paid in.

Brokers can be paid huge commissions for selling endowment policies, so make sure that you have asked how they will be paid to determine whether a product is really good for you, or simply high paying for them.

Some people may have no need for life insurance, for instance if they have no dependents and enough assets to pay off the loan.