Money for Nothing

1) Endowment Mortgages Which were interest only mortgages with an added ‘endowment policy ‘ that was the product that would repay the loan. For it to be able to fully compensate the principal amount it relied on a stock market growth of 7-9% per annum over the lending period. Using compounding interest year on year to compound the growth,

What could possibly go wrong?

Turned out, a lot”.

The reality of the over optimistic long term calculations of 7-9% growth (note inflation was at 10-12%, 1980-90’s) soon hit the endowment market, as year on year inflation (which eats into debt as well as savings) dropped as the economy slowed and thus so did BOE interest rates, which was bad news for Endowment Policies whose projections were based on a former overheating economy with an inflation inducing end date for government mortgage subsidies. Over the next 20 years more market crashes (1992, 2002 ,2008) reduced the averages of market growth as each cycle had to regain its losses before the real long term growth that these products needed could get back on track. But with slow annual growth for the economy (1-3%), inflation dropping to below 4% and subsequent BOE interest rates to below 2% the policies continues to fall behind projected final maturity values.
When it became apparent that many who took such policies would have a short fall on the agreed payment date, the lenders started chasing for increased payments to cover the shortfall or conversions to traditional repayment mortgages. It was only then that the mis-selling became apparent as most assumed that the endowments would cover their mortgages with a potential surplus, and this was the heavily promoted pitch that lured so many (including me) into what seemed the obvious wise choice, it was a bank/building society after all, and we trusted these old established institutions, how wrong we were.

Why did we agree to these endowments rather than traditional mortgages?
Pressured selling, as the new independent agents who sold them had huge fees paid to them by the lenders and insurance companies who backed and profited from the potentially high compounded returns that the projections foretold in a high inflation economy. Whereas the general public saw banks and building societies as trusted entities just like a doctor;

“you’re the expert, I’m not, I will take and trust your advise as you have no reason to be dishonest

The reality was that the regulation was not up to date on these new products. They later failed to fulfill their marketed promises and thus resulted in huge claims for compensation for mis-selling, this was supported and regulated by new regulations when it came obvious to the Government of the day that mortgagees would not be able to fulfill their contracts to pay the full sum on the agreed date ( note; they were only paying the interest on the principle). And thus gradually the mis -selling option began to evolve, eventually backed up in law by the Financial Services Association (FSA) of whom Lenders had to be licensed to, to be able to legally trade.

The real question arises, how much of a gamble was this product, or to be more succinct did they know that high inflation actually never lasts long (which devalues debt as incomes rise) and stock market growth historically is 5% over the past 200 years?

The years from 1988-2013 (25 years) produced an Annualized Rate-of-Return (ROR) over that period of 3.9%. I was paying £540 per annum (monthly payments of £45) to achieve a minimum of £33,750, the actual amount would have been £22,926 (ROR @3.9%) a third short. To get to £33.750 I would’ve needed a ROR of 6.6% over 25 years.

Why did they think 7%+ figure was possible?
The recent past of the lived experience of high inflation in the early 1970’s (world OPEC oil crisis) and to a lesser extent in the early 1980’s it seemed that high inflation was the norm and therefore higher market growth rates. If you by chance took the same 25 year period from 1974-99 the return would have been 14.1%!. But this period apart from War and/or revolution is now in hindsight considered a historical blip, (based on a 200 year timeline (ref; Thomas Piketty and Mark Blyth), we have returned to, on a rolling 25 year interest model from 1980 to the present to the historical peacetime market growth of >3% but <5% and income growth of around 1%.

These Endowment style mortgages are now banned. Interest only mortgages you need at least 50% deposit with assets to the value of the other 50% available to secure the loan.

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