Mortgages - Protection and Funding

REPAYMENT MORTGAGE - PROTECTION

Introduction
If you are considering taking out a mortgage to buy your private residence on a repayment basis, you will be repaying part of the capital with each payment you make.

Structure: level repayment
You will repay a level amount each year, consisting partly of repayment of capital and partly of interest. As the capital outstanding reduces year by year, each payment will consist of a smaller amount of interest and a larger amount of capital.

Mortgage protection policy
Life assurance cover should be arranged on the mortgage. It is suggested that you start a mortgage protection policy on the lives party to the mortgage to repay the amount of capital you still owe if any life party to the mortgage dies before the loan is repaid. The sum assured under such a policy gradually decreases as the loan is being repaid; it therefore keeps the cost of the life cover to a minimum.

Level term assurance
Level Term Assurance can also be considered as part of an overall individual and/or family protection. Not only can the mortgage and other debts be repaid but a structured plan for the financial security of the family can also be considered.

Personal pension term
The policy can be written under the personal pension plan rules and the premiums would therefore be fully allowable against your income, thus securing relief at your top rate of tax.

Life cover and critical illness
Lives party to the mortgage should consider being covered against both death and critical illness. A combined policy will cover you against either of these events, whichever occurs first.

Assignment of policy to lender
The lender may require the life assurance policy to be assigned to them. Then, if you die, the proceeds will be passed to them in the first instance in order to pay off the loan. If there is any surplus that will be repaid to the deceased estate.

ISA/OEIC/UNIT TRUST MORTGAGE FUNDING

Interest-only loan
The mortgage involves paying only interest to the lender and instead of making capital repayments, you make contributions each year into an Individual Savings Account.

Individual savings account
An individual savings account (ISA) has significant taxation advantages under current legislation, because the investments bought and dividends received will be free from any liability to personal taxation. This means that the investment should grow faster than any comparable investments on which some tax will be paid.

OEIC/Unit trust savings plan
A OEIC/Unit Trust savings plan has a significant taxation advantage because the OEIC/unit trust itself does not suffer any capital gains tax when it realises investments. The dividends it receives from UK companies carry a tax credit and it currently pays corporation tax on its other income at 20%, so that income which has already suffered deduction of tax at source will not be liable to further tax.

However, in your hands income received or accumulated on your behalf would currently have a tax credit of 10% and the grossed up amount would be included in your total income for higher rate tax but not basic rate or starting rate tax purposes.

When you sell units in an OEIC or unit trust, you may be liable to capital gains tax in the usual way [see appendix 7 ]. However, you are entitled to the annual exemption from capital gains tax, currently £8,800 a year for each individual.
[Cross reference appendix 7]

ISA mortgage suitability An ISA or OEIC/unit trust mortgage would only be a suitable arrangement if you are fully aware of the risks associated with these arrangements. The main risk is that if there is insufficient funds at the end of the mortgage term other arrangements will need to be made to repay the loan. If you are unsure about the risks associated with investment linked mortgages you should seek professional advice.

ENDOWMENT OR PENSION SHORTFALL

Introduction
Many people who opted for Endowment or Investment linked mortgages in the past have received letters projecting a shortfall in funds at the end of the mortgage term. This assumes that the underlying funds achieve a future investment return set by the Financial Services Authority.

Reason for shortfall
The main reason for the shortfall is that past performance has been less than assumed at outset and future investment returns are projected to be lower than envisaged when the policy/policies started.

Continuing policies

If you decide to continue the investment linked policy to meet any shortfall you could:

Extend mortgage term
Extend your mortgage term by a number of years, subject to the agreement of your mortgage lender. The revised mortgage term should aim not to run beyond your current planned retirement date if possible .If this is the only solution careful consideration as to the affordability post retirement should be considered.
Leave mortgage term unchanged
Keep your mortgage term unchanged but make other provision for the shortfall which could be higher as well as lower than that projected by the investment company.

Convert part to repayment
Converting part of the existing mortgage to a repayment basis, subject to the agreement of your mortgage lender. The amount converted to repayment mortgage should be equal or more than the projected shortfall on the investment companies illustration. If the underlying funds of your existing investment policy achieve an investment return shown on their illustration, there would be sufficient to clear the balance of your mortgage. Note: the illustrations are not normally guaranteed and the maturity values may be lower as well as higher than the figures shown.

Affordability
Based on your analysis of likely future income and expenditure, the additional cost should be considered affordable, taken together with your existing mortgage-related payments. If not then professional advice should b sought.

INSURANCE COVER

Insurance
It is essential that adequate insurance cover is taken out with respect to all loans

Life assurance
Life cover should be taken out on all parties to a mortgage.

PHI
It is important to have income protection (permanent health insurance) on the parties to the mortgage. Income protection provides a replacement income if you are disabled and cannot work and home-carers policies provide a valuable income if a non-working partner is disabled.

Critical Illness Insurance
It is also essential to have critical illness cover on the parties to the mortgage. This will provide a lump sum following diagnosis of one of the defined critical illnesses covered by the policy, such as heart attack, stroke, most forms of cancer as well as permanent and total disability. It is recommended that you should include this feature so that you have the peace of mind of knowing that your mortgage will be repaid in these circumstances.

Redundancy In addition you should consider redundancy insurance. This could meet your mortgage costs for a period of normally up to 11 months if the policyholder were made redundant. Initial payments from the plan would be deferred usually for one months but check the policy provisions.

Even if you satisfy the strict eligibility requirements for Income Support, the Department for Work and Pensions (DWP) will not make any payments to cover your mortgage interest for the first nine months after a claim is made to them. The maximum amount of borrowing covered by the DWP is £100,000