A Possible Gem for Home Mortgage Seekers – the Growing Equity Mortgage

OK, let’s have a quick review of Residential Real Estate Economics 101:  Increasing Equity – GOOD; Stagnant Equity – BAD.

With that synopsis in mind, home borrowers in search of a suitable mortgage may want to consider a type of loan that falls under the category of alternative mortgages, namely, the growing-equity mortgage (GEM). 

So how is this type of mortgage different than the more common “run-of-the-mill” fixed-rate mortgage – after all, don’t all mortgages allow you to build equity?  Well, some do more than others.  And there lies the beauty of the growing-equity mortgage – it helps you build equity in your home more rapidly than with other types of mortgages, hence,  its name.

So, what’s the magic behind it?  Basically, a growing-equity mortgage is one in which the borrower’s interest rate is fixed – usually a few percentage points lower than the going market rate, while the monthly payments increase, periodically.  The lender can offer a lower interest rate since the principle payments are exaggerated.  And, although the payments start out small, they increase gradually over the life of the loan, based on an index, such as the U.S. Commerce Department index, or an agreed-upon schedule. 

The overriding principle behind this financial product assumes that the borrower’s income will rise appreciably over time – enough to meet the graduated payment agenda. Equity gains are much faster due to the fact that the payment increases are applied completely to the principle.  Thus, it is not uncommon for a 30-year mortgage loan to be paid off in less than fifteen years.

Who is it designed for?  Young families or first-time homebuyers can probably benefit the most from a growing-equity mortgage.  In fact, those low or very-modest income homebuyers, who don’t have the funds to meet initial upfront costs associated with obtaining a “traditional” mortgage, and who would find difficulty in meeting the financial obligations involved with maintaining said mortgage, would be prime candidates for a growing-equity loan.  However, the borrower should feel confident in his or her prospects, concerning a faster-than-average rising income, in order to satisfy the demands of the ever-growing monthly payments before seeking a GEM.

What are the benefits?

• Equity, Equity, and more Equity – gains are realized quite a bit faster than with more conventional loans
• Greatly-reduced total interest costs over the loan’s life.
• The actual loan term is shortened by many years, as long as the borrower doesn’t deviate from the payment schedule.
• Substantial savings can be realized during the early years of the mortgage – due to its initially small monthly payments.

What’s the downside?

The main one – there’s always the danger that the borrower’s income may not keep pace with the monthly payment hikes.  For example, the index changes might be more drastic, or the borrower’s income boosts may be smaller than anticipated.  In addition, long-term tax deductions are not offered with this type of mortgage.