Making Up A Shortfall

If you are an endowment mortgage holder, your provider should have sent you a number of 'reprojection letters'. These inform you whether or not your endowment policy is likely to repay your mortgage, and if not, what the likely shortfall will be. These letters should be colour-coded, so that it is clear whether or not your policy is expected to repay the full amount borrowed: red if there is a very high risk of a shortfall, amber if there is a substantial risk and green if it is likely to repay the full amount. These reprojections can change: if your policy is currently on track, it doesn't necessarily mean that it will definitely repay the full value of your mortgage in several years time.

If your endowment policy, like millions of other homeowners', is not likely to pay off the full amount you borrowed, you need to make up the shortfall. There are several possibilities to do so:

Your mortgage lender is likely to suggest increasing your monthly payments. This means that you slowly make up the shortfall by increasing the value of your investment. However, the stock market is volatile and there is still no guarantee that your policy will reach the desired value. In addition, you could be charged a penalty fee for 'altering' the endowment policy.

The second option is to switch the type of mortgage from interest-only to repayment. This means that your monthly repayments will pay off part of the loan amount as well as the interest charged. It is usually easy to transfer your mortgage, but your repayments will tend to cost you more each month because you are no longer paying off the interest alone. In most cases, your lender does not have to convert your whole mortgage to a repayment loan. This means that the cost of converting is reduced, because you are not expected to repay the entire loan with repayments: your endowment policy is still used to pay off the bulk of your mortgage. If a reprojection is later made that increases your endowment shortfall, you can decide to convert more of your mortgage to a repayment loan to make up the difference.

Alternatively, you may choose to convert your whole mortgage to a repayment loan. Although your monthly repayments would be much larger, you are guaranteed to pay off your mortgage at the end of the term (assuming you make every payment on time and in full). In this case, your endowment is no longer used to repay the loan amount, which means that you can cash it in immediately. If you do this, you no longer receive life cover and could lose out financially. Alternatively, you may decide to continue paying into the policy as an additional savings option. You have the added benefit that you do not have to arrange separate life insurance. An endowment investment can be complicated and you could lose money if you cash it in early. Seek professional financial advice if you are unsure what is best for you.

Your fourth option is to find an alternative savings or investment plan, such as a Cash or Stocks and Shares ISA, that could make up the shortfall. If you have not been paying your mortgage very long, saving in a Cash ISA may not prove the best value for money, since cash savings tend not to increase as well as investments over the long term. In addition, there is a limit to the amount you can save each year (£3,600 in 2008/2009). There are benefits to Cash ISAs however:

• you do not pay tax on interest earned in a Cash ISA (Individual Savings Account)
• they are a secure option for the short-term, since growth is not based on stock-market performance

Alternatively, you may choose to invest in a Stocks and Shares ISA. This allows you to invest up to £7,200 (in 2008/2009) a year, tax-free. As this is an investment which relies on the performance of the stock market, it is not advised for short-term growth. Seek professional financial advice if you are unsure as to how this type of ISA could help you make up a shortfall on your mortgage.

The fifth option is to repay part or all of your mortgage early (before the end of the mortgage term). You can do this by choosing to overpay each month, or paying off the entire mortgage in one lump sum. In many cases, this is the option which offers the best value for money, since the overall cost of your mortgage would be much lower. Some lenders will allow you to repay early without incurring a penalty charge, but you should ask them if you are unsure because a large charge could reduce the overall benefit of early repayment.

In contrast, you may choose to extend your existing mortgage term. Although this will increase the overall cost of your mortgage, your monthly repayments would be more affordable. However, it is not advisable to extend the term into retirement; your future retirement income is likely to be much lower than your current income, and as such, your mortgage repayments could be unaffordable.

Alternatively, you may choose to sell your endowment policy. You can sell your endowment policy to a company specialising in trading endowments. They usually sell these on to private individuals, who then benefit from the growth when the policy matures. In some cases you will get more back by selling it to a specialised company than you would from your original lender.

It is essential that you decide how to make up a shortfall as soon as possible, since failing to do so may result in the loss of your home. Before making a decision, seek professional advice from an independent financial advisor. This can help ensure that you get good value for money and choose the option that is best for you.