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.
- 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
### What is the primary feature of a Growing-Equity Mortgage?
- [ ] Decreasing monthly payments
- [x] Increasing monthly payments
- [ ] Variable interest rates
- [ ] Fixed loan term
> **Explanation:** The primary feature of a Growing-Equity Mortgage is that monthly payments increase annually by a predetermined amount, which helps to pay down the principal faster.
### How are the additional payments of a GEM applied?
- [ ] Towards interest only
- [x] Towards the loan principal
- [ ] Towards fees and charges
- [ ] Towards taxes
> **Explanation:** The additional payments in a Growing-Equity Mortgage are applied directly to the principal, which accelerates loan amortization.
### Which type of borrower is a GEM most suited for?
- [x] Someone expecting an increasing income
- [ ] Someone whose income will remain constant
- [ ] Someone expecting a decreasing income
- [ ] Someone retiring soon
> **Explanation:** A GEM is most suited for borrowers who expect their income to increase over time, as they will be better able to handle the rising payments.
### Does a GEM generally have a fixed or variable interest rate?
- [x] Fixed interest rate
- [ ] Variable interest rate
- [ ] Both fixed and variable
- [ ] Neither
> **Explanation:** A GEM typically has a fixed interest rate, with only the payment amount increasing over time.
### What effect does a GEM have on the maturity of a loan?
- [ ] Lengthens the maturity
- [x] Shortens the maturity
- [ ] Leaves the maturity unchanged
- [ ] Depends on interest rates
> **Explanation:** Due to accelerated principal payments, GEMs often shorten the maturity period of the loan compared to traditional mortgages.
### Which of the following best describes amortization in the context of GEM?
- [ ] Increasing loan balance
- [ ] Constant loan term
- [x] Gradual principal reduction
- [ ] Fixed payment amount
> **Explanation:** Amortization in a GEM context refers to the gradual reduction of the loan principal through increased monthly payments.
### What happens if a borrower’s income does not increase as anticipated with a GEM?
- [ ] Payments will decrease
- [x] It may become difficult to manage the rising payments
- [ ] Nothing changes
- [ ] The loan term extends
> **Explanation:** If the borrower’s income does not increase as anticipated, managing the rising monthly payments may become difficult, leading to potential financial strain.
### Are GEMs typically longer or shorter in loan term compared to Level-Payment Mortgages?
- [ ] Longer
- [x] Shorter
- [ ] The same
- [x] Variable
> **Explanation:** GEMs usually have a shorter loan term due to the accelerated principal payments which pay off the loan more quickly.
### What aspect of the borrower’s situation does a GEM hinge on?
- [ ] Interest rates
- [ ] Type of property
- [x] Anticipated income growth
- [ ] Loan term
> **Explanation:** A GEM hinges on the borrower’s anticipated income growth, which allows them to manage increasing payments effectively.
### Are prepayment penalties common with GEMs?
- [ ] Always
- [ ] Rarely
- [ ] Never
- [x] It varies based on the specific loan agreement
> **Explanation:** Prepayment penalties vary based on the terms agreed upon with the lender in the loan agreement, so it is essential to review the contract details.
Thank you for diving into the details of Growing-Equity Mortgages (GEM). Continue expanding your knowledge in the realm of mortgage options and financial literacy!
