What is a Growing-Equity Mortgage (GEM)?
A Growing-Equity Mortgage (GEM) is a residential mortgage loan that features scheduled increases in monthly payments. These incremental increases are earmarked primarily for the principal balance, which leads to a faster loan amortization. In contrast to a traditional fixed-rate mortgage where payments remain constant, a GEM accelerates the repayment of the loan by gradually increasing payment amounts—reducing the overall interest paid over the life of the loan.
Key Characteristics:
- Scheduled Payment Increases: Annual increases based on a percentage, typically tied to a specific index or fixed schedule.
- Principal Reduction: Extra payments are directed towards reducing the loan’s principal.
- Shorter Loan Term: Due to accelerated principal repayment, the loan term is often significantly shorter.
Examples of Growing-Equity Mortgage:
- Example 1: A homeowner obtains a GEM with an initial mortgage payment of $1,000 per month. Each year, the payment increases by 5%. By the fifth year, the monthly payment would be approximately $1216, with much of the extra amount going towards reducing the principal.
- Example 2: Another borrower starts with a GEM having a starting payment of $1,200 per month, which increases by 3% annually. By year six, the monthly payment would be $1,391. The borrower will pay off the mortgage more rapidly compared to a fixed-rate mortgage.
Frequently Asked Questions (FAQs)
Q1: Can the interest rate of a GEM change over time?
A1: No, GEMs typically have a fixed interest rate throughout the life of the loan. The payment increases are only applied to the principal.
Q2: What is the typical loan term for a GEM?
A2: The loan term for a GEM can vary but is typically shorter than the standard 30-year mortgage due to the accelerated principal payments.
Q3: Is a Growing-Equity Mortgage ideal for everyone?
A3: No, GEMs are best suited for borrowers who anticipate their income will increase over time, allowing them to handle the rising payments.
Q4: How does a GEM affect mortgage amortization?
A4: A GEM results in faster mortgage amortization because the increasing payments gradually lower the balance owed on the principal more quickly.
Q5: Are there prepayment penalties for GEMs?
A5: Prepayment penalties depend on the loan terms agreed upon with the lender. It’s advisable to review the mortgage agreement for specific details.
Related Terms
- Principal: The amount borrowed or the remaining balance of a loan, excluding interest.
- Level-Payment Mortgage: A mortgage that has equal monthly payments throughout the loan term.
- Amortization: The process of gradually paying off a debt over a period through regular payments.
Online References
Suggested Books for Further Studies
- “The Mortgage Professional’s Handbook” by Richard Brizek
- “The New Mortgage Handbook” by Alan Fields and Denise Fields
- “Mortgage-Backed Securities: Products, Structuring, and Analytical Techniques” by Frank J. Fabozzi
Fundamentals of Growing-Equity Mortgage (GEM): Mortgage Basics Quiz
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