The loan market just got murkier

Abbey National is planning to stop selling endowment mortgages - still taken out by one-third of homebuyers - shortly after the introduction of Individual Savings Accounts next month.

The move comes amid a growing backlash against mortgage endowments, with regulators stepping up monitoring of endowment sales and some providers signalling that they may fail to pay off mortgages.

Abbey National is expected to replace endowments with an ISA mortgage, which will use the ISA's ?1,000 annual life insurance element as the vehicle for repaying a mortgage.

Abbey National's move is highly unusual; no other major lender is using the life insurance element of the ISA as a mortgage repayment method, preferring the stocks and shares element instead.

But mortgage brokers are already warning homebuyers to steer clear of ISA mortgage packages offered by high street lenders. London & Country mortgage adviser Patrick Bunton says: "I would look very closely at the charging structure. Halifax switched out of endowments into Peps some years ago, but customers ended up being offered a product that was almost as bad as an endowment when it comes to charges."

Straightforward repayment mortgages should be the choice for an "overwhelming majority" of homebuyers, says Mr Bunton.

On April 6 this year, ISAs replace Peps and Tessas, and are promising to be one of the most complex and confusing financial products ever.

There will be two types: the "maxi" and the "mini". The maxi-ISA must contain a stock and shares element up to ?5,000, and may contain either the ?1,000 annual cash maximum and/or the ?1,000 annual life maximum, all looked after by the same financial institution.

The mini-ISA is made up of just a single component of either cash (max ?1,000), insurance (max ?1,000) or stocks and shares (max ?3,000). To complicate matters further, during the first year of the ISA, the maximum investment limit will be ?7,000 rather than ?5,000.

Under an ISA mortgage using the insurance element, the homebuyer will pay up to ?83 per month into a life insurance product such as a with-profits fund. The expectation is that, like an endowment, this will roll up in value sufficiently to pay off the mortgage at the end of the term.

But the ?1,000-a-year, ?83 per month limit means that an insurance ISA mortgage can appeal only to people with mortgages below ?70-80,000.

Halifax is also launching an ISA mortgage to replace its "HomePlan" Pep mortgage, using the ?3,000 a year stocks and shares element of the ISA. Like the former Pep mortgage, money will be paid into the Halifax Accumulation unit trust in the hope that this will repay the mortgage at the end of the term.

In the switch to ISAs, Halifax is cutting the initial charge on unit trust to 5 per cent from 7.5 per cent, but the fall only brings it into line with the industry average. Customers with existing Pep mortgages will also have to sign instructions to Halifax to transfer to an ISA. If they don't - and up to 10,000 Halifax mortgage customers have yet to do so - they will lose their tax-free advantages.

The ISA mortgage adds another choice to the array of methods - including endowments, capital repayment, pension and flexible - to repay a loan. Here, we guide you through the repayment maze: Flexible mortgages are the latest ploy - and allow you to borrow not just for a house, but for anything else as well. The plans are certainly popular. Half the new Woolwich mortgages are flexible loans, though its Open Plan mortgage appeared only nine months ago.

How does it work? The bank will lend you up to 90 per cent of your prospective property's value. You may buy a house for ?100,000, but need a mortgage of just ?50,000. But if you qualify to borrow up to ?90,000 overall, ?40,000 is available for other loans. The interest rate on that money will be the same as for the mortgage itself. Repayment mortgages provided the original homeloans and 10 or 15 years ago people used to sneer at them as fuddy-duddy. Now there is an enormous swing back to them.

Repayment loans ensure you pay back a mixture of capital and interest as the loan progresses, though the proportions in each month's repayments do vary dramatically.

Early payments are almost all interest, and those at the end are almost all capital. So your debt does not fall as fast as you expect. The crucial point is that you repay the capital via the mortgage and not via some outside contract like an endowment or a PEP. Endowment mortgages involve more risk - but potential reward. Anyone with a 25-year loan takes out a 25-year endowment policy, whose proceeds go on paying back the capital they have borrowed. In the past these policies have earned more than enough to pay off mortgages, but many "low-cost" endowments pioneered in the 1980s boom are not on course to pay off the loan. Endowment mortgages are not cheap and the first year's insurance premiums go into advisers' commission and start up costs - not into investment for you.

This also means that few endowments cashed in their early years even repay the amount of premiums paid in.

The terminal bonus, which appears only when the policy matures, can also vary sharply from year to year - although it usually provides up to half the policy's value. Pep mortgages - soon due to disappear - ensure you can save via a personal equity plan, collecting some tax relief in the process. The lenders organise an interest only loan in the meanwhile.

But you can cash in the PEP when you want, though you will need money to pay off the mortgage itself, when it is due. Stocks and shares-based ISA mortgages will work in much the same way. Pension mortgages give you tax relief at your top rate on what you put away, but can never generate the same sums as other contracts.

The reason is easy to understand. You can take a only quarter of your pension savings as a tax free lump sum to settle the mortgage, for the rest has to go on buying a pension.