Re: Endowment compensation - complex example
- From: Ronald Raygun <no.spam@xxxxxxxxxxxxxxxxxxxxx>
- Date: Thu, 24 Aug 2006 14:21:35 GMT
Black Hole (o) wrote:
Can anyone please give me some idea how I should go about calculating any
endowment compensation due when the circumstances are rather more complex
than the nice simple ones I always seem to see given as examples.
Imagine that I have the following loan history:
- Loan 1, Lender 1, £30,000 interest only, from Jan 1988 to Dec 1997
- Loan 2, Lender 2, £34,000 interest only, from Jan 1998 to Dec 2002
- Loan 3, Lender 3, £38,000 interest only, with regular overpayments,
from Jan 2003 to Dec 2004 and a discounted rate for first 12 months
- Loan 4, Lender 3, Additional £10,000, interest only,
with regular overpayments, from Jan 2005 to date
For mis-selling purposes you cannot realistically take into account the
extra borrowings in Januaries of 1998, 2003, and 2005, unless you bought
additional endowment policies to cover this extra borrowing. The policy
you have was only intended to grow to £30k over the term, and you will
have been expected to find other ways to repay the subsequent additional
borrowing.
And the following endowment policy premiums on a £30,000 low start
endowment policy:
£40 per month from Jan 1988 to Dec 1992,
£80 per month from Jan 1993 to Dec 2005
Policy surrendered for £20,000 end Dec 2005
For loans 1 and 2, I know how much I paid out each month, but not the
interest rate, but I assume that can be reverse engineered (approximately)
month to month from the loan amount and the payments made.
Indeed. The interest rate would simply equal twelve times the monthly
payment divided by £30k, except where this needs ti be adjusted to take
account of MIRAS, and except where the payments don't change when the
rate changes, but at the next anniversary of the loan advance. The MIRAS
complication should be easy to take care of, and the deferment of payment
amount changes is probably safe to ignore.
For loans 3 and 4, I still have the statements, so I know the monthly
payments and the interest rate actually applied.
In the spreadsheet I set up, when attempting to work out what the
equivalent repayment mortgage would have cost, I included £6 per month for
Decreasing Term Assurance for a 30 year old male non-smoker and a 29 year
old female smoker, starting back in Jan 1988. Am I in the right ball park
here, or can someone provide a better figure?
I guess so.
Do I need to take the effects of MIRAS into account, and if so how would I
go about it.
Yes, you should. It's not easy in general, but in your case it is. Setting
MIRAS aside for the moment, you know how to calculate the monthly payments
on a repayment mortgage, I take it: You use the monthly interest factor f
(this is 1 plus a twelfth of the annual interest rate, so if the nominal
annual rate is 6%, then f=1.005).
Then, if n is the number of months in the term (300 for a 25 year term):
(monthly payment) = (amount borrowed) * (f-1) / (1 - f^-n) [formula A]
If the interest rate changes after m months, you will first need to
calculate the debt remaining:
(amount left owing) = (monthly payment) * (1 - f^-x) / (f-1) [formula B]
where x is the number of months *remaining* in the term: x = n-m
You then plug this "amount left owing" into the formula A in place
of "amount borrowed", and x instead of n, to calculate the new monthly
payment for the new interest rate. That is to say the new payments are
the same as if you were to take out a new loan, for the amount now still
owing, but for a shorter than the original term, since the redemption
date is presumed to remain fixed.
Just keep going with formulas A and B like this for all rate changes and
finally work out the amount owing on surrender date. Subtract this from
the original £30k to get the amount you have "paid off", and this is the
figure to be compared to the surrender value of the endowment. You will
also need to track the differences in monthly costs associated with
interest-only vs repayment. You may need to scale all these by inflation
to get their surrender-date-equivalent values before adding them all up.
Now to MIRAS. Since your loan was only for £30k, which happens to be
the MIRAS limit, all your loan qualified for this relief, so you can
do your monthly payment calculations by simply using a scaled-down
interest rate. So for periods when MIRAS was 20%, then if the interest
rate was 6%, use 4.8% instead (this being 80% of 6%). For larger amounts
outstanding, the above simple formula cannot be used and an iterative
process must be used to calculate the monthly payment.
In fact, you don't need to bother with MIRAS at all, as it comes out
in the wash. This is because you can calculate your net-of-MIRAS
interest rate from your interest-only payments, and use that rate in
your repayment amount calculations.
There is the extra complication of your low-start years, and the question
arises how this would be modelled for an "equivalent" repayment loan. It
is conceivable they might assume the existence of a loan product which
applied a £40 monthly discount to the normal monthly payments for the
first five years. If so, then each time you apply formula A, you would
subtract £40 from the answer to get your actual monthly payment (if in
the first 5 years), and it is this reduced payment you should plug into
formula B to get the new amount owing.
.
- References:
- Endowment compensation - complex example
- From: Black Hole \(o\)
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