Out of the frying pan, into an ISA

The endowment mortgage is dead, long live the ISA. That appears to be the refrain from big lenders such as Abbey National and Halifax, which have recently piled into ISA mortgages. But are ISA mortgages likely to be a better bet than controversy-ridden endowments?

ISA mortgages work on the same principle as endowments: you invest in a fund which is expected to build up enough cash to repay the mortgage at the end of the term, usually 25 years.

Problem one is that they carry the same investment risk as endowments. If the stock market does not grow rapidly enough, homebuyers will be forced to cough up extra money to make up the shortfall. That fear alone should deter many homebuyers from taking out these products and opt for a simple repayment mortgage instead.

Problem two is that the ISA mortgage seller will urge you to add on life insurance and critical illness premiums. These can add £100 per month to the mortgage repayment, and the bank or building society selling you these extras is unlikely to be the cheapest on the market.

Problem three is "assignment" You cannot assign an ISA to a lender; it is, therefore, very easy to stop payments into the plan without the lender knowing. So if people run into financial difficulties and forget to make payments, they are unlikely to be forced to find the money. The underpayment may not emerge until the end of the term of the mortgage, when the debt is so large that it will be unpayable. The result could be the loss of the family home.

Problem four is commission. Endowments were sold heavily because advisers picked up huge commissions, which they would not have earned if they had recommended a repayment mortgage instead. ISA mortgages pay less commission, but may still slant advisers to recommend them. An endowment to cover an £80,000 mortgage earns an adviser at least £800. But an ISA deal with life and critical illness cover will still earn them around £600 - significantly more than if they were selling a repayment mortgage.

ISA mortgages do have advantages over endowments. They are tax-free, so the investment will grow more rapidly than an endowment. They have lower charges, typically 5% on each premium plus a 0.5% annual charge on the fund, and are better value than an endowment if they are cashed in early.

Abbey National and Halifax both insist that there will be no commission bias on their recommendations, as their advisers earn most of their income from salary plus a bonus from the overall branch performance. They also say that investment risk is fully explained to customers and that they have systems in place to avoid the assignment issue.

But the Consumers' Association believes they are suited only to a small number of people - compared to the 50% of new mortgages at Halifax which are ISA-based. Money researcher Neil Walkling says: "They are still interest-only mortgages, so there is still a risk. We think they are only suitable for a minority of financially sophisticated people."

Meanwhile, the clamour over endowments continues to grow. Jobs & Money readers this week highlighted how hopes that endowment losers might obtain refunds by going to the PIA Ombudsman may prove unfounded. Raymond Masters, from Chandler's End in Hampshire has an endowment that was sold on the promise of a payout of £32,000, more than enough to cover a £23,000 mortgage. But the company, Britannia Life, now says it is only on target to produce £17,000. When he contacted the Ombudsman he was told that they could only look at policies taken out after April 29, 1988, when the Financial Services Act came into force. He was advised that he may have to take legal action.

Another reader, Alf Game from Swindon in Wiltshire, highlighted how requested increases on endowment policies are far more than the 50% which our survey two weeks ago indicated may be the maximum. His Eagle Star policy, to repay a £30,000 mortgage, has just seen its premium soar from £37.60 per month to £67.68 per month - a jump of 80%. "Growth rate projections have been in decline for some years, so I am unable to understand why Eagle Star did not advise me to increase the premium some years ago " he says.