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Case Study Two – Debt Management

Situation

Liz and Steve were very risk averse.
They had no confidence in the stock market, regardless of what anyone said. Of particular concern was an endowment policy they had bought 15 years ago which was linked to their mortgage. The latest correspondence was a ‘red warning’ letter saying the plan would not achieve the target required. They did not wish to launch complaints of misselling, but with retirement only a few years away, they required an action plan.
The last adviser they had met had tried to persuade them to invest their considerable spare income into stock market based investments; however, they had many reservations about doing this.

The details:

-They have an interest only loan of £76,000 at a rate of 5.35% to 2010

-If the policy grew at 4% it would produce a maturity value of £43,000 in 2010 (the endowment was originally set up to cover a loan of £55,000)

-The current surrender value of the endowment is £36,000

-The endowment premium is £80 per month

What We Did

When we started discussions, it became rather obvious which route they should take as their mortgage was up for a rate review and there would be no redemption charges.

Liz and Steve were planning to shop around for the cheapest deal and remortgage for two years, sometimes known as “rate tarting”.

After verifying their attitude to risk, the alternative we put to them was:

  • Remortgage to a flexible offset loan at a rate of 5.04% with daily interest
  • Sell/surrender the policy and use the proceeds to reduce the mortgage
  • Pay the original endowment premium of £80 per month into the mortgage
  • Pay an additional £1000 per month they had as spare income into the mortgage
  • Open current accounts for both Liz and Steve linked to the loan, which would offset against the mortgage
The Result
To summarise:
  • Loan paid off in 30 months, rather than a shortfall of £33,000 in 2010
  • Debt paid off is a no risk strategy achieving a return of 5% which suits Liz and Steve’s attitude to risk
  • Peace of mind for the clients
A very important overall point here is a very valid question – “should I use spare monies to pay off debt or to invest for our future?”

The best way to answer this is to look at the risk profile of the client using psychometric risk profiling. We then can interpret the results to give a rate of return that the client would be comfortable with – say 7%. If they are paying 5% on their mortgage, then it is reasonable to advise them to adopt an investment strategy, as they are aiming for a higher return than the cost of the loan.

But if their risk profile indicated that they should only accept a return of say 4% and the debt was costing 5% – then it may be wiser to repay the debt.
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