Safe as houses?

As returns from endowment mortgages continue their downward spiral, more and more customers are looking around for alternative ways of paying off their home loans. And while the number of borrowers opting for traditional repayment mortgages has understandably burgeoned in recent years, there are plenty of people who have chosen an interest-only mortgage.

In the mid-90s, some financial providers began to favour Isa mortgages as a replacement for discredited endowments. With an Isa mortgage, a borrower invests in an individual savings account and uses the proceeds to pay off the loan at the end of the term. The Isa holds shares, either in individual companies or in unit and investment trusts, and the proceeds are allowed to grow tax-free.

Isa mortgages are often marketed on their flexibility: customers are only tied to their product provider on an annual basis, so it is perfectly possible to use a different, better-performing provider each year. The charging system is more transparent than with an endowment and it is relatively easy to spread risks between funds. Above all, if it performs well you could pay off your home loan early.

But, as with any interest-only home loan, an Isa mortgage is totally dependent on the performance of the investment vehicle backing the loan - in this case, the Isa - and most independent financial advisers (IFAs) warn it is only really suitable for customers prepared to take some degree of financial risk.

According to Anna Sofat, joint managing director of independent financial advisers Fiona Price and Partners, an Isa mortgage is not really a product for the average man-in-the-street, nor is it an alternative, or replacement, for an endowment. "You need to know your tolerance of risk," she says. "It's not for the fainthearted. You have to know what you are doing, and you have to keep an eye on it."

Philippa Gee, investment director with independent financial advisers Torquil Clark, agrees:
"Most people have to keep their mortgage low-risk and this does not necessarily go hand-in-hand with an Isa. It can be a super investment, but should be separate from your mortgage repayments," she advises.

Isa mortgages do tend to be more expensive than repayment loans and Anna Sofat estimates that in order to cover the interest payments and charges on the Isa - say, 4% on the mortgage and 1.5% on management charges - you need returns of at least 6%, merely to stay afloat.

Elliot Nathan, mortgage development manager with Bradford & Bingley's The MarketPlace, also points out that anyone with an Isa mortgage has to do their homework on the history of their chosen funds and companies and then has to keep a sharp eye on their performance. If they are unable or unwilling to do this themselves, they will need to employ a fund manager - and the cost of such a manager can be high.

So while Isa mortgages are flexible, it must be remembered that this flexibility does come at a price and can itself have disadvantages. Although lenders conduct periodic reviews of the performance of Isas sold in relation to mortgage loans, most will not offer this service to customers who make their own arrangements and change providers regularly.

According to Mr Nathan, another frequently overlooked disadvantage of Isa mortgages is that, unlike endowments, they do not have built-in life cover. He stresses that it is absolutely vital for anyone considering an Isa mortgage to make separate life cover arrangements.

In recent years, a combination of falling stock market values and high, hidden charges, have resulted in many Isa mortgages failing to meet their targets. Some, in fact, are now worth considerably less than the sums paid in. This is particularly galling for those consumers who, on finding a couple of years ago that their endowment policies were falling short, took out an Isa top-up and now face the nightmare scenario of neither policy reaching its target.

Yet despite their shortcomings, IFAs insist that Isa mortgages do have their place.
"They can be very risky and are definitely not for everyone," says Elliot Nathan. "They are very different from endowments and will never be as popular, but can be one alternative as an interest-only mortgage for people who do not want a repayment mortgage."

"You do need to be very careful and be prepared to accept a considerable level of risk," says Philippa Gee, "But different people have different requirements and, as with any other major financial commitment, it is vital to take independent, expert advice before deciding on an Isa, or any other mortgage."