Growing-Equity Mortgage (GEM)
Definition
A Growing-Equity Mortgage (GEM) is a mortgage loan in which the payment increases by a preordained percentage each year. The additional amount from these increasing payments is directly applied to the principal balance of the loan. This method of repayment results in the loan’s payoff period being significantly reduced compared to a standard fixed-payment mortgage.
Examples
Example 1: Sarah takes out a growing-equity mortgage to purchase her new home. Her initial monthly payments start at $1,000. Each year, her payments increase by 4%. The additional payment amounts are applied to the principal, allowing her to pay off the loan faster than if she had chosen a traditional fixed-payment mortgage.
Example 2: John buys his condo with a $200,000 growing-equity mortgage. In the first year, his payments are $1,300 per month, which increase by 3% each year. By the fifth year, his monthly payments are $1,463. This additional payment towards the principal accelerates the payoff schedule significantly.
Frequently Asked Questions
Q1: How does the payment increase affect the pay-off period?
The increasing payments applied toward the principal means that the loan can be completely paid off much sooner than a standard fixed-rate mortgage.
Q2: What happens if the payments become unaffordable?
If the payments become unaffordable, the borrower may need to negotiate with the lender for a possible refinance or modification of terms, provided the lender offers such options.
Q3: What are the benefits of opting for a GEM?
The primary benefit is the reduction in total interest paid over the life of the loan due to the faster reduction of the principal balance. It also allows quicker accumulation of equity in the property.
Q4: Are GEM loans common?
GEM loans are not as common as traditional fixed-rate or adjustable-rate mortgages, but they can provide advantages for certain borrowers looking to pay off their mortgage quicker.
- Principal: The amount of money borrowed that remains unpaid, excluding interest.
- Maturity: The end of the term of the loan, at which point the loan should be paid off.
- Level-Payment Mortgage: A mortgage with equal fixed payments over the life of the loan.
- Amortization: The process of gradually paying off a loan through scheduled payments.
- Refinancing: The process of replacing an existing mortgage with a new loan, often with different terms.
Online Resources
References
- Investor’s Guide to Real Estate, John P. Wiedemer
- Real Estate Financing, Gerald R. Cortesi
- The Mortgage Encyclopedia, Jack Guttentag
Suggested Books for Further Studies
- “Investing in Real Estate” by Andrew McLean and Gary W. Eldred
- “Your Guide to Understanding Mortgages” by Adam Holtzschue
- “The Real Estate Wholesaling Bible” by Than Merrill
Growing-Equity Mortgage (GEM) Fundamentals Quiz
### How does a Growing-Equity Mortgage affect the loan's pay-off period?
- [x] It significantly shortens the pay-off period.
- [ ] It extends the pay-off period.
- [ ] It does not affect the pay-off period.
- [ ] It keeps the pay-off period identical to the original loan term.
> **Explanation:** The increased payments go towards the principal, significantly shortening the pay-off period compared to a fixed-payment mortgage.
### What is the primary advantage of a Growing-Equity Mortgage for the borrower?
- [ ] Larger monthly payments from the start.
- [ ] Fixed monthly payments.
- [x] Faster build-up of equity and reduced loan term.
- [ ] Easier initial qualification.
> **Explanation:** The primary advantage is the faster accumulation of equity through additional principal payments, resulting in a shorter mortgage period.
### What happens to the extra amount paid each year in a GEM?
- [ ] It goes toward interest.
- [x] It is applied to the principal.
- [ ] It is used for mortgage insurance.
- [ ] It is refunded to the borrower.
> **Explanation:** The additional amount is used to pay down the principal balance of the loan.
### How often do payments increase in a Growing-Equity Mortgage?
- [ ] Monthly
- [x] Annually
- [ ] Bi-annually
- [ ] Semi-annually
> **Explanation:** Payments in a GEM are designed to increment annually by a predetermined percentage.
### What is one potential risk for borrowers with a GEM?
- [ ] The interest rate might change.
- [ ] The property might depreciate.
- [x] The increasing payments may become unaffordable.
- [ ] The loan term is fixed regardless of payments.
> **Explanation:** The escalating payments can become difficult to manage if the borrower’s income does not increase correspondingly.
### Compared to a level-payment mortgage, how does a GEM affect the total interest paid over the life of the loan?
- [x] It reduces the total interest paid.
- [ ] It increases the total interest paid.
- [ ] It doesn't affect the total interest paid.
- [ ] It increases the principal balance.
> **Explanation:** By paying down the principal more quickly, the total interest paid over the life of the loan is reduced.
### Can Growing-Equity Mortgages be refinanced?
- [x] Yes, depending on lender terms.
- [ ] No, they cannot be refinanced.
- [ ] Only after 15 years.
- [ ] Only when real estate values rise.
> **Explanation:** Like other mortgage types, a GEM can typically be refinanced subject to lender approval and the borrower's qualifications.
### What type of buyer is a Growing-Equity Mortgage ideal for?
- [x] Someone expecting their income to grow steadily.
- [ ] Someone wanting stable payments.
- [ ] Someone with no expectation of income growth.
- [ ] Someone looking for long-term payment stability.
> **Explanation:** A GEM is best suited for borrowers expecting a steady rise in income, enabling them to handle increasing payments.
### What factors should borrowers consider before choosing a GEM?
- [ ] Fixed interest rates only
- [ ] Property location only
- [x] Income growth potential and ability to handle escalating payments
- [ ] The color of the house they are purchasing
> **Explanation:** Borrowers should assess their potential income growth and ability to manage increasing payments over time.
### What differentiates a GEM from an Adjustable-Rate Mortgage (ARM)?
- [x] Payment increases in GEMs are planned and go towards principal.
- [ ] Both adjust payment terms periodically based on interest rates.
- [ ] GEMs have variable interest rates.
- [ ] There is no difference; they are the same.
> **Explanation:** GEMs have planned annual payment increases applied to principal, unlike ARMs, which adjust based on interest rate changes.
