Mortgage misery for ISA investors

Endowments may have turned sour, says Jasmine Birtles, but those advised to jump on another repayment vehicle have fared even worse

If you thought endowment loans were the devil incarnate, pity the poor souls who were sold individ- ual savings account (ISA) mortgages.

Endowment policies may have traditionally been taken out alongside interest-only mortgages to repay the capital at the end of the loan period, but since their popularity began to wane, pensions, personal equity plans (Peps) and ISAs have each had their turn as the "in thing" among lenders and financial advisers.

The problem now is that borrowers who were seduced by these trendy ideas are typically facing shortfalls of around 50 per cent of what they need to repay their mortgages on time. In fact, many are in a worse position than endowment holders, whose shortfalls tend to be much smaller.

"ISAs backing these mortgages will have been invested 100 per cent in the stock market, unlike endowments, which are only partly invested in shares. So they will have performed even worse," says Ray Boulger of mortgage broker Charcol.

Many of the six million potential victims of the endowment scandal have been hit by the ISA letdown too. When news of shortfalls began to emerge, some people who had endowment mortgages were advised to set additional sums aside in an ISA to increase their chance of repaying their loans.

"People who used ISAs to shore up their endowments are now looking at shortfalls on their shortfalls," says Jane Harrison of mortgage broker London & Country. "People shouldn't be sold products. [They should buy products which suit their individual circumstances.] And as for those doing the selling, what did they go on to sell when endowments lost their popularity? ISA mortgages."

Launched in April 1999, during a strong bull market, ISA home loans quickly became fashionable. The fact that profits were tax-free was a big selling point. The City watchdog, the Financial Services Authority, even suggested that investors assume average growth of 7 per cent a year with ISAs, as opposed to 6 per cent for endowments, because of this tax break.

Big lenders, such as the Halifax and Abbey National, invented Pep mortgages in the mid-1990s. After April 1999, when ISAs replaced Peps, around 100,000 households were persuaded to gamble on the stock market as a way to finance the repayment of their mortgage. Meanwhile, the lenders happily pocketed 5 per cent from every monthly contribution.

Many of those with an ISA mortgage may not realise that they are well behind target. While endowment holders receive regular updates – including red, amber and green letters – customers with pension, Pep and ISA mortgages are not told if their investments have any chance of repaying their mortgages without extra contributions. So far, only a handful of ISA plans have been reviewed; some are red and some are amber, indicating that they will fail to pay off the loan. Most people will only be told their fate once their plan has been in force for 10 years.

So what should you do if you have an ISA mortgage? "Assuming you took it out for the right reasons, you shouldn't cut and run now," says Mr Boulger at Charcol. "Just as it's no good selling shares now that they're at or near the bottom, it's best to wait for the markets to go up – as they will in time."

Although analysts are advising investors to buy more shares now because prices are so low, be careful before embarking on an ISA mortgage.

"It very much depends on the buyer's attitude to risk," cautions Mr Boulger. "The majority of people won't want to take the risk because they're worried about the stock market."

'We're glad the stock market's gone down'

Not everyone has had a bad experience with ISA mortgages. Brothers Noel and Claude Vella, both accountants living in Surrey, took out an interest-only loan with the Halifax in August 2001. At the same time, they started an ISA to pay off the capital at the end of the investment term.

Both are relatively sophisticated investors, with a portfolio of shares, and were under no illusions about the state of equities. "We actually welcome the fact that the market's gone down," says Noel, "because we'll be hanging on to the ISA for 10 to 15 years and we're only interested in the price at the beginning and the price at the end. The lower the market is in the meantime, the cheaper the units that we're buying each month."

The brothers decided to invest in the Foreign & Colonial Investment Trust through their ISA because it has very low charges and a good spread of UK, US and international blue chip equities.

"We're putting quite a lot into the ISA every month but we've also been paying off some of the capital of the mortgage," says Noel. "So far we've paid off about 25 per cent."

They are now planning to put their house on the market as it has appreciated in value, but they will keep the ISA going. "If house prices come down to a sensible level we could buy another one, but if not we'll put the extra money into the stock market while it's low."