Some bank brokers are still selling mortgage bond linked endowment assurance policies something that should be an absolute no-no, particularly with current high interest rates.
How these policies normally work is that you take out a mortgage bond for say R100 000. Instead of paying back the loan you only pay the interest. The money you would have used to pay off the capital is instead used to pay for the premiums on an endowment assurance policy.
In theory when the time comes to pay off your bond 20 years hence, your policy will have accumulated enough capital to redeem your home loan and leave a bit of spare cash besides.
How does it work in practice, particularly, as I mentioned, with the current high interest rate?
NORMAL MORTGAGE BOND REDEMPTION:
If you borrowed R100 000 and paid off both the capital and the interest at 18 percent (let's take the most preferential mortgage bond rate generally available), after 20 years you would have paid off R368 792 (interest R268 792,73 plus capital of R100 000).
THE ENDOWMENT OPTION:
The average return on endowment policies has not been much beyond 15 percent on average over recent years and in many cases considerably lower.
Your premiums on a policy with a maturity value of R100 000 after 20 years with 15 percent compounded growth would be R80 a month. The total you would pay in premiums would be R19 200.
At the end of the period you would have paid R360 246 in interest to service the unpaid capital plus the assurance premiums of R19 000. Total amount paid over 20 years would be R379 246. The capital would be repaid by the maturing assurance policy.
Your interest under the endowment option is higher than the normal bond capital redemption option because when you pay off your capital, as the amount reduces so does the amount of interest you pay every month. On the endowment option you pay about R1 520,00 in interest every month, depending on the number of days in the month.
The interest you pay in the first month is the same as the last month after 20 years whereas under the normal repayment you have reduced the interest to almost zero when you make your final bond payment.
It appears that in selling these products the banks and the assurance companies involved are contravening the life assurance company agreement called the basic illustration agreement.
The agreement was introduced to prevent life assurance companies and brokers making exorbitant claims about investment performance. In terms of the agreement they are only allowed to project performance at nine and 12 percent.
To have a policy mature at R100 000 after 20 years at a 12 percent compounded growth you would pay a premium of R125 a month or R30 000 for the full period.
To have a policy mature at R100 000 after 20 years at a nine percent compounded growth you would pay a premium of R175 a month or R42 000 for the full period.
HOW MUCH YOU WOULD LOSE:
Endowment option at 15 percent: R379 246
Less normal redemption: R368 792
Endowment option costs you: R 10 454
Endowment option at 12 percent: R390 246
Less normal redemption: R368 792
Endowment option costs you: R 21 454
Endowment option at 9 percent: R402 246
Less normal redemption: R368 792
Endowment option costs you: R 33 454
These figures become even worse if you are paying an interest rate of more than 18 percent on your bond.
On the basis of these figures it is interesting that any bank will permit the continued selling of these endowment policy options for normal home buyers.
The only area where these options may work is if a property is bought for an investment, but it is unlikely that the taxman would allow you to get away with showing the same interest loss year after year.
Ask the banks, which permit the selling of the product, about what is going on and most either do not reply to the enquiries or refer to the life companies or the brokers. The fact that they can stop the practice appears to escape their notice. This practice must also be a contravention of the assurance industry's basic illustration agreement as well.
One method used to hoodwink you is that an escalation clause is added which can give the appearance that you are reaching the capital targets within the nine and 12 percent limits but this comes at a higher premium cost, which even at 10 percent mounts up rapidly over the 20 years.
A final problem is that with the endowment option you are locked into a 20-year contract. Under the normal repayment scheme you can increase your payments and repay your bond sooner, saving a considerable amount on interest.