What you need to know about Growing Equity Mortgages

If you want to prepay your mortgage, you can build equity fast and avoid any prepayment penalties of some conventional fixed-rate mortgages by obtaining a growing equity mortgage (GEM). It is also sometimes called a rapid-payoff mortgage.

GEM interest rates are usually lower than that for a fixed rate mortgage. You lock into an interest rate that remains fixed throughout the life of the loan. The difference is that your monthly payments begin at about the same level as those of a 30-year fixed rate mortgage, but then gradually rise. Over a five to 10 year period your payments will increase annually then level off. Increases are usually based on a schedule or changes in an economic index.

FHA currently offers several GEM plans. The first year the loan is paid on a 30-year schedule. Every year afterwards the payment will increase between 1 and 5 percent. The term of the mortgage can’t exceed 22 years and is often less. This is not a very popular choice among homebuyers in today’s uncertain economic climate.

GEMs are often attractive to first-time homebuyers who may not be quite ready to take on a large house payment but that expect their income to rise. This often enables them to buy a home sooner than they could with regular financing. The bigger payments allow the borrowers to pay more toward the principal of their note and can take years off the life of their mortgage. The shorter term and faster repayment make GEMs attractive to mortgage lenders and investors, too.

Because you pay less interest, GEMs don’t offer much when it comes to long-term tax advantages – you’ll have less interest to deduct. You also should make sure that you’ll have the income increase to pay the larger payments.