From: Ronald Raygun 
Subject: Re: endowment mis-selling compensation calculation
Newsgroups: uk.finance
Date: Fri, 12 Nov 2004 22:28:18 GMT

john boyle wrote:

> In message , Tim  writes
>>So, if you had had a repayment mortgage, you would have paid off more
>>capital each month with a standard variable rate than with a discounted
>>rate.
>>
> 
> No. That is the exact opposite of what really happens.
> 
> 100K @ 12% repayment mortgage = repayment of £12750 in first year of
> which (using annual rest system) £12k is interest and £750 is the
> capital reduction.
> 
> 100K @ 0% repayment mortgage = repayment of £4000 in first year of which
> (using annual rest system) £0 is interest and £4000 is the capital
> reduction.
> 
> At ALL points during the life of a repayment mortgage a loan with a
> HIGHER rate of interest will have a larger capital amount outstanding
> (all other factors being equal)

That's absolutely correct, of course, provided you pay the amounts you
should, as determined by the usual repayment calculation formula, given
amount, rate, frequency, and term.

But when comparing repayment against endowment, you need to compare on
the one hand the sum of interest-only and endowment premiums with on
the other hand the hybrid repayments.  This should be suitably adjusted
as necessary by either deducting the cost of life insurance on one side
or adding it on the other.

Basically, you need to keep a running total (which preferably also takes
part in the discounted cashflow, i.e. is subject to compound interest) of
the difference between what the two methods actually cost you month to
month, and then offset the total paid off at the key moment by whatever
that running total stands at at the same moment.

One way of doing this is, instead of assuming a standard repayment
scheme loan, to postulate an open-ended scheme, rather like interest-only
with optional overpayments, taking the option to make constant overpayments
equal to what would have been the endowment premiums less insurance element.

If you do it like that, then the higher rate will have you pay the debt
down faster.

This is because, as you know, the excess of standard formula repayments
over interest-only payments is smaller at higher interest rates, which is
after all the reason you'd normally pay down more slowly at higher rates.
But in our scenario we would pay the same excess at all rates, not less
at the higher rate.