A Growing-Equity Mortgage (GEM) is a type of mortgage loan characterized by increasing payment amounts each year. The additional amount from each payment increment is specifically applied towards the principal retirement, which significantly shortens the maturity period of the loan.
Key Characteristics
Annual Payment Increase
In a GEM, the borrower’s payments are structured to increase by a predetermined amount annually. For example, payments might increase by 1% to 5% each year.
Principal Focus
The incremental payments are directed entirely toward reducing the principal balance. This accelerated principal repayment leads to substantial interest savings over the life of the loan.
Types of Growing-Equity Mortgages
GEMs can vary based on the specifics of their increase schedules, usually determined by:
- Fixed-Rate GEMs: The interest rate remains constant, and only principal payments increase.
- Adjustable-Rate GEMs (ARMs): Both the interest rate and payments can adjust periodically, although the major focus is still on increasing principal repayments.
Historical Context
The GEM was developed in the 1970s as a response to high inflation and the need for more adaptable mortgage products. It provided a solution for borrowers to build equity faster and reduce the overall debt burden more efficiently compared to traditional mortgage products.
Practical Example
Consider a $200,000 GEM with an initial annual payment of $12,000 (or $1,000 per month) and a 5% increase per year. In the first year, the monthly payment is $1,000, but in the second year, it becomes $1,050 per month, and so on. The additional amount paid (e.g., $50 extra per month in the second year) goes directly towards reducing the principal.
Comparison to Level-Payment Mortgage
- Level-Payment Mortgage (LPM): Monthly payments stay constant throughout the period of the loan. Typically, these payments include both interest and principal in a way that slowly reduces the principal balance over the loan’s term.
- GEM: Payments increase annually, with the entirety of the increment applied to principal, leading to faster principal reduction and shorter loan maturity.
Related Terms
- Principal: The original sum of money borrowed in a loan, or the remaining balance of that sum yet to be repaid.
- Level-Payment Mortgage: A traditional mortgage where the monthly payment amount remains constant for the duration of the loan term.
FAQs
What is the main advantage of a Growing-Equity Mortgage?
Is a GEM suitable for all borrowers?
How does the increasing payment structure affect my financial planning?
Can I refinance a GEM?
References
- “Mortgage Market Innovations: The Creation of Adjustable-Rate Mortgages, Graduated Payment Mortgages, and Growing-Equity Mortgages in the 1970s.” Journal of Housing Research.
- “Personal Finance: Turning Money into Wealth” by Arthur J. Keown.
- U.S. Department of Housing and Urban Development - HUD.gov.
Summary
A Growing-Equity Mortgage (GEM) is a specialized mortgage offering where payments increase annually, and the additional payment amount is applied toward the principal. This results in faster equity build-up and a reduced loan maturity period compared to traditional level-payment mortgages. Ideal for borrowers anticipating rising incomes, GEMs offer significant interest savings and an expedited path to loan payoff.
