a look back in anger at the endowment, a popular investment of yesteryear

Twenty-eight years ago I perpetrated the worst financial mistake of my entire life so far. I bought a house, in the hugely overvalued market of 1989. It seemed a good time to look back at how this happened, because today the Pru, one of the partners in crime regarding endowment mortgages, tells us that one in four retirees have never recovered from that kind of 1980s style cockup, and are carrying mortgage debt into retirement.Not only that, but three more waves of the the financial instrument of wealth destruction otherwise known as the interest-only residential mortgage will be crashing on the battered shores of British residential mortgagees in the next 15 years. I was only the advance guard.

Very few people are rich enough to have saved enough money to be able to service big existential debts like a mortgage in retirement, so the financial whizz-kids seem to be selling these guys equity release plans to fix the failure of their younger selves to live within their means by eschewing one or more of holidays, kids, pets or general consumerism. I recently came across the documentation for that piece of feckless financial foolishness, so I thought I’d deconstruct it here. Obviously Brits have learned in the intervening three decades, so our housing market is not at sky-high earnings multiples with people signing away a quarter of their gross earnings nowadays. Or maybe not…

You don’t have much control over when you come of an age when you need to find somewhere to set up house, most of the choices in that respect were taken by your parents and determined by the human life-cycle set by Nature. There’s a window somewhere between 25 and 35 when you need to tackle this issue. Your experience of housing will depend on what phase of the market cycle housing is in, plus some wider long-term societal changes, many of which are adverse. Cycles in the housing market a long – 10 years is not enough to see a whole cycle. I was a single man competing with an increasing number of dual income households because women were entering the workforce in larger numbers. I had already been driven out of the city of my birth by rising house prices and I really really wanted to buy a house, so much that I ignored alarm bells, massive factory sirens, red lights set at danger and just about every other indication that I was paying way too much. All I could afford was a two up two down where most of my colleagues from previous years were able to buy a semi on a typical graduate salary at The Firm. This even shows now – as an old git I am thinking of moving upmarket rather than down, because my hatred of the property asset class ran so deep that I never moved from the semi I bought a decade later.

feckless financial foolishness deconstructed:

Buying a house at that time was bad enough, but I compounded my mistake by choosing an endowment mortgage, because I was a foolish and greedy 28-year old. My parents had said the only way to buy a house was with a repayment mortgage, and made a decent case of as to why. So I listened to the sales patter of how a endowment could make even more than the capital, all tax-free, and the pound signs lit up in my eyes and in about half an hour I doubled down on the error of overpaying, signing up to this promise

So putting my 28 year older and wiser head on my 28 year old body, let’s take a look at what is wrong with this. If the promise had held good I would have paid 25 × 644.52 = £16113 to get £41500 in 25 year’s time. Which is a fantastic deal, what’s not to like? Ker-ching. Oh and my mortgage gets paid off if I die early. To be honest that’s not my problem, I suppose I should have made a will, because that was never going to benefit me – strike one. What I heard in the sales patter was a very good chance of doubling the money. What the dimwitted 28-year old failed to take into account is that I damn well should expect to double my money in 25 years time – at the time half the value of money died through inflation every 10 years, so in 25 years that profit would be worth diddly squat. I was clearly not reading the documentation right, because it only offered an extra 15k using the most racy projections, sustaining an investment return of over 10% p.a. for twenty-five years straight. Easy peasy.It’s the selective focus bias – you see what you want to see.

To get this putative win, I had to take an investment product described in the vaguest terms I have ever seen – never mind active or passive management, there was no idea of fees or anything else, it boils down to a statement of –  we will give it a go, but nothing is guaranteed, sunshine.

There is no transparency whatsoever, but hey, the salesforce can say anything to big this up. If this offer came across my desk nowadays, the second word would be “off”. At least I can say I made some use of the intervening three decades to get a little bit wiser.

So what happened? Let’s take a look at the state of play after fifteen years had rolled by, that’s half a working life in my case

Well, the good news is that I get about £5000 more than I’d have paid in at the minimum guaranteed sum. The bad news is that even with a total return after fees of 8% p.a. sustained for ten years I’d have been £11k short. Now in 2004 £11k looked like a lot of money to me, and I was pretty damn sure that I didn’t want to eat this loss. [ref]I am being slightly disingenuous here, because Friends Provident demutualised in 2001 and I got about £7k in shares which I sold immediately, and used to make a capital repayment, which I guess brought the outstanding amount to  about £34k.[/ref]

It seems that unlike 25% of my fellow endowment suckers I took action during the term of my mortgage to pay the bugger down, and eventually I kicked up enough fuss that Friends Provident paid me off with a bung in 2005, which I also used to make a capital repayment. Then as my career began to flame out and crash and burn in 2009 I started paying down more and more of the capital, adopting a financial brace position against no longer having an income. That’s actually a really dumb thing to do for people who are trying to retire earlier than 55, but fearful people make bad decisions sometimes, and that was mine. It meant I was poorer in the last few years, but I will be richer from about now – the mortgage could have smoothed my cashflow between retiring from work and getting to 55.

Look at those mad assumptions

Even in 2005 they were talking about investment returns of 8% a year. That just ain’t gonna happen on a sustained basis, and the lowest assumption of 7% way back in 1989 turned out to be total codswallop. That was the risk-averse cautious assumption – it’s bloody nuts. This was massive sample bias due to inflation – after all, just ten years before I signed up inflation in the UK was running at over 15%. You know what the man from the FCA says

Past performance is no guide to the future

Well yeah, but WTF else are you going to go on – Tarot cards or reading tea leaves? Mystic Meg? Inherent in the very fact of stock market investing is the nasty little assumption that you can qualify what you will get in the long run informed by what happened in the past[ref]this dirty little secret is inherent in the SWR and things like firecalc are doing nothing other than informing you from past performance[/ref]. Nevertheless, the 28-year old me could have avoided all those mad assumptions by doing the sensible thing and getting a repayment mortgage. Epic fail in market timing and choice of repayment method.

Winter is coming…

What’s really bananas is that people didn’t learn from the endowment mortgage debacle. Look at this chart from this FCA confidential[ref]I downloaded it on 17/2/2017 from https://www.fca.org.uk/publication/research/fca-interest-only-mortgage-review.pdf[/ref] report published on the open web

Oh boy, there is serious incoming hurt from these maturing IO residential mortgages over the next 15 years

Wages are stagnating, though I guess the high Brexit-induced inflation has reduced all these guys capital debts by 20%. Let’s hope their wages keep up with inflation, eh, because otherwise Winter is coming, and it will be served up with a good amount of Discontent. Their pain will be worse too, because at least I had a deficient repayment method that would have paid about half of the capital. Since then interest only mortgages were written without any requirement to have a method of repaying the capital at the end, so these big cohorts are coming to the end of their 25 year extended home rental term aka interest only mortgage, and the requirement to actually buy the house will come as a bit of a surprise by the looks of it. Okay, so they have taken a call option on the price 25 years ago, but they’ll still need to whistle up the price or move out.

Tighter Lending? Interest-only mortgage timebomb? That was set ticking years ago

Shock across the nation as our biggest building society, the Nationwide, KO’s the interest only mortgage. Apparently it means there’s an interest-only mortgage timebomb that’s just gone off! Oh No! The Daily Mail’s Simon Lambert tells us

Do you have an extra £400 a month spare to spend on your mortgage? That is the kind of the potential rude awakening that awaits millions of homeowners with interest-only mortgages the next time that they want to move home or remortgage. Many of them will be blissfully unaware that their personal interest-only mortgage timebomb exists.

Well, no. Let’s reframe this a little bit. Joe and Josephine First Time Buyer wander into ther friendly local building society to see the manager, Mr Wolf. The conversation goes like this

JJ: we’ve seen this lovely little house and we’d like to buy it with some of your money, please.

Wolf: okay, we’ll take a look. So you want to borrow £250,000 over twenty-five years you’ll pay us back the money and we’ll have to charge interest on it I’m afraid.That will be £10,000 capital and £12500 interest at 5% each year[ref]I have brutally simplified the complexities of mortgage interest calculations, it’ll do for this[/ref]. How do you feel about paying £1875 a month for your house?

JJ oh that’s far too much. Here, how about we just pay the interest?

Mr Wolf thinks  Interest-only? pleasure doing business with you, Josephine’

Wolf: oh, okay then, that’s just £1041 pcm by then

JJ: fantastic, where do we sign up?

furious scribbling of documents. JJ leave with smiles on their faces. Just as they turn to leave, they say

JJ: Thank you so much Mr Wolf!

Wolf: And thank you, JJ. I’ll have retired by then, but my successor will be along in 2037 to pick up the keys to the house when we take it back. Great doing business with you. [bares rows upon rows of pearly teeth in a smile]

Therein lies the rub. If you can only afford the house of your dreams by just paying the interest on the loan, then your dreams are too big for your pocket. You can’t afford the house, and in practice your shortfall is about half.

Of course, this isn’t how people think about it. Typical thinking is epitomised in this Torygraph article about Tough New Mortage Rules to hit First Time Buyers and borrowers in their 50s. What part of ‘home owner’ does the Torygraph not get? To own something, you pay all of it, not just the interest on the credit card used to buy it.

Here what they have to say about one of the more pernicious pieces of financial engineering over the last decade or so, the interest-only mortgage

Because they have lower monthly repayments, these types of loans have in the past helped millions get onto the housing ladder.

There’s a perfectly good alternative way of looking at this

Because they have lower monthly repayments, these types of loans have in the past helped millions to overpay by about twice for their houses, which they will never get to own.

Doesn’t sound so nice put that way, does it?It also fundamentally builds in a deep need for house prices to rise nominally. Not in the abstract I feel richer because my net worth has risen way, but in the ‘Aaargh I owe more money than I’d get if I sold up‘ way.

Now for those hard pressed 50-somethings for whom the Telegraph’s heart is bleeding, because, shock horror,

It will pose difficulties for people who are in their 50s wanting to take out a typical 25-year mortgage. For example, a 55-year-old would struggle to obtain a home loan because it would not be paid off until they were 80.

Well, er, yes, I mean the obvious question has to be asked of Johnny-come-lately.

You should be owning your house free and clear, not getting a 25 year mortgage at your stage of life. Two score years and ten + 25 into three score years and ten won’t go!

A mortgage is a way to place a claim on the value of your future work to buy something expensive now.  The Jobcentre doesn’t have many outlets six foot under. You’re a rotten risk compared to a 30 year old, because over the next 25 years you’re more likely to die and you’re much more likely to lose your job permanently, plus you don’t exactly show an awesome track record of saving. That’s forgivable in a 30 year old but not in a 50 year old. So thanks but no thanks, we won’t be lending you any money!

If I wanted to take out a mortgage now I would damn well expect the mortgage firm to ask me how I was going to repay the interest and capital within ten years or less. If I couldn’t afford it I’d expect them to tell me to get on my bike. And I’d expect them to demand life insurance to discharge the mortgage should I peg it in the duration.

As you get older a mortgage simply isn’t a good product for much of the equity in your main residence. If you need one, you aren’t rich enough to be able to afford to live there, unless you can pay a 10 year repayment mortgage. If I want to buy another house I either use the accumulated equity in my current house by selling it, adding cash if I upgrade, or I pay cash for it or I secure a mortgage on it as a financial investment like a buy to let mortgage, but then I don’t get to live in it.

stick half your working life into ten thousand or so of these, or…

But – but – but it’s so unfair! I can hear the wannabe homebuyers of the country thinking. This actually will work in your favour over the next few years. It will stop all those other jerks offering way over the odds for houses using their interest only mortgages. That will reduce demand at current prices, and the sellers will have to eat crap and drop their prices. Which means less of your lifetime earnings will go into housing, and more into foreign holidays, and meals out. It’s not all bad, eh? What would you rather have, 25 years of sun sea and sand or a pile of mute bricks soaking up your dreams?

alternatively add 25 years of beach holidays to the mix by overpaying less?

So not only are current buyers sinking more of their lifetime earnings into houses, they don’t get to own the damn things at the end! That’s the ultimate tragedy of the commons – it’s nuts from a collective viewpoint but rational from a individual viewpoint, because everybody else is at it. It a rough deal and It.Must. Stop – so good on the FSA for finally putting an end to this racket[ref]Unlike in the past when lenders would take a primary charge on an asset this has many loopholes. Lenders would be required to check at least once during the term of the loan that the savings pot its still in place. I am happy to say I back a borrower for a month during the check with the contents of my ISA in return for a fat fee and the insurance premium, and I am sure there’ll be others providing the service on a commercial basis ;)[/ref] Yes, the buyers from 2006 and 2007 will get to eat the crow, just like I did after buying in 1989. The only way for prices to go up as fast as they have done over the past 20 years again is if we start to have Japanese or Swiss-style intergenerational mortgages. Let’s hope the regulators aren’t asleep at the switch if that idea raises its ugly head, eh? The level-headed Swiss are probably more competent to handle that sort of thing, the gnomes didn’t get to watch over the assembled loot of the rich for generations without showing some track record of financial nous. It still seems barmy to be, but most nations have at least one widespread bizarre national quirk that looks mad to the rest of the world.


UK home ownership. From Nationwide, http://www.nationwide.co.uk/hpi/historical/Feb_2012.pdf

In Britain before Thatcher, a lot fewer people owned[ref] In the UK people say they own their houses even if they have a mortgage. I personally believe I only owned my house when I discharged the mortgage, but nearly all stats use the more general used sense of owned by the finance provider on behalf of the borrower[/ref] their own homes (50% as opposed to todays ~70%)[ref]about 50% in the mid 1970s as compared to ~70% now[/ref], and they invariably took out either repayment mortgages or purchased an investment that was intended to repay the capital at the end of term in combination with an interest only loan, and the building society took a primary charge on that investment. I was shocked when I moved in 1999 and the building society didn’t ask me how I was intending to pay the 40% extra that wasn’t covered by the endowment I had at the time. I switched the mortgage to a 60% interest-only (covered with an endowment) and 40% repayment mortgage. Incredulously, I asked the mortgage adviser what he expected to happen at the end, to which he replied most people want to keep the payments down as much as possible.

Well, I didn’t. I intended to pay my debts thanks all the same, and had to kick up a fuss to do so. There are a few sharp people around who know how to play an interest only mortgage. They are very few and far between, and the interest-only mortgage is a Weapon of Wealth Destruction in most people’s hands. There are two ways that it destroys wealth. One is people getting repossessed if they stretch themselves too far, but there’s a much more insidious way it destroys wealth.

It lets many people overpay for houses, bidding the price up too much

Houses are effectively sold by auction, because they aren’t easily comparable or interchangeable with others. If you can borrow interest only, you can ‘afford’ to bid roughly twice as much as if you actually had to pay that money back over 25 years. Ergo, the price of houses goes up about twice. This goes for other means of artificially supporting house buyers. Every single attempt by governments or other agencies to make them ‘more affordable’ has simply jacked the price up to compensate.

This benefits the providers of capital, ie the banks and building societies because they get to lend twice as much money. The higher price helps housebuilders, but all this doesn’t help the borrowers one bit. Of course banks were up for interest only mortgages – they got to lend a lot more money that way!

We had a much less dysfunctional housing market before Thatcher got in there and started buggering about with it. Those who couldn’t afford housing lived in council housing if they had children and lodging or bedsits if they didn’t, and a small proportion bought a house using a mortgage.There was a lot wrong with council housing, but in general it worked for a much wider range of society than social housing seems to now.

Britain is a small island with a lot of people in it. The sad fact is that not that many people can really afford to truly buy a house over a working life. The 1970’s ratio of 50% is probably on the high side. The even sadder fact is that all the muddling with the housing market has jacked prices up so much that an even lower percentage of people will probably get to own their houses in future.

The interest-only mortgage timebomb started ticking roundabout when I remortgaged to move, when mortgage providers let people get out of the door without having a repayment strategy in place. But we can’t just place the blame on the providers. The borrowers have to take a teeny bit of the blame too, for not asking themselves the question I asked myself in 1999. That question is

how am I going to pay back the money I have borrowed, 25 years after I sign up on this dotted line?

It has been surprisingly possible to achieve this in the past, probably because mortgage companies only lent money to people they expected to be able to repay it, rather than indulging in NINJA loans.

homes owned outright almost at parity with ones on a mortgage

I was surprised to discover this graph  [ref]DWP[/ref] showing the percentage of people that own outright, compared to ‘owning’ with a mortgage. I hadn’t expected 50% of owner occupiers to be mortgage free. I suspect this will be lower in 25 year’s time when Joe and Josephine approach the end of their working lives, precisely because of those interest-only mortgages. The bank will have made a shedload of money, though not as much as they lost lending money to Americans without any money. And JJ still won’t own their house, though they will have the warm glow from feeling they were worth a lot of money way back when. One of their best hopes is this fellow

With a bit of luck he’s devalued the currency enough that the capital cost of their house is worth the price of a Mars bar and a pumpkin latte.

They might wish to bear in mind my experience as a cautionary tale, then. I stupidly paid way over the odds for a two-up-two-down in 1989. Sticking a sly paw into Merv’s back pocket to borrow the inflation calculator the Ermine dicovered that the inflation-adjusted value of this amout in 2011 was over two-thirds of the price of my current house. Now the capital doesn’t appreciate on an interest only mortgage, but even the original capital amount is a third of the price of my current house. Zoopla tells me it is about half the price of a house of the same type in the same road as the one I owned. Yes, inflation is your friend, but not as much as it was in the 1970s.

Oh and Mr Wolf? Happily retired and studying the phases of the moon with his telescope.