Endowment Mortgage
Endowment mortgages are special variety of mortgages. They consist of two contracts, i.e., a contract between the lender and the borrower, and the second contract between an insurance company and the borrower. Both the contracts are entered into at the same time. Endowment mortgage allows the borrower to defer the payment of principal component out of the traditional EMI i.e., the equated monthly installment.
Any EMI is comprised of two parts, i.e., the interest, and the principal. The interest part of the EMI keeps on diminishing each month because the EMI of the previous month had some amount of principal in it. This principal amount is reduced from the outstanding principal and interest is calculated on such revised principal. But the EMI has to remain the same. Therefore, any drop in interest component is compensated by proportionate increase of the principal component within the overall limits of the EMI. This EMI when paid regularly every month eventually exhausts the loan amount. This entire process is called amortization.
In endowment mortgages, there is no principal component within the EMI. This means, the borrower pays an EMI that has only the interest component, and this interest component remains uniform throughout the term, whether the interest rate applicable on the mortgage is adjustable rate or fixed rate. The dues are all pushed towards the later part of the mortgage term. Endowment policy associated with endowment mortgage is expected to generate enough money at the end of the term so that the outstanding loan amounts can be cleared. This might seem like the principal amount from the EMI is being diverted towards the premium for this policy. However, the amount payable towards premium is much less when compared to the usual component.
In addition, this premium amount also earns some regular profits on these amounts. Such profits are known as reversionary bonus. At times though, the policy may be unit-linked, i.e., the insurance company may float a fund with units, and these units may be allocated to the person against the premium funds. Therefore, even though the sum assured under the policy may not be equal to the outstanding loan amount, eventually, it may be almost equal to the outstanding loan. This will help the borrower clear the dues.
This can also become a good reason for the borrower choosing to take an endowment mortgage. Apart from this advantage, the endowment policy also includes an insurance of borrower's life. This is good for both the borrower as well as the lender. Such insurance secures the lender's dues in case the borrower dies within the loan term. As far as the borrower is concerned, the dependents are spared some financial liabilities.
Like all other mortgages, there are tax benefits associated with endowment mortgages as well. The interest paid in any year on endowment mortgages is deductible from the income of that year. This reduces the tax liability of the individual. Even the premium towards life insurance is allowed as a deduction. Therefore, the borrower can save taxes using endowment mortgages. It may be argued that the interest being paid is much higher than in any conventional mortgage loan. While this is true, it must also be remembered that any interest that is being paid in this fashion is steadily losing its value because inflation reduces the purchasing power of the money. If all future cash outflows were discounted at inflation rates and brought to present value, it would be obvious that the effective interest rate is much lower. Therefore, endowment mortgages make sense.