A Growing Equity Mortgage, or GEM for short, is a type of mortgage where the amortization rate is based off of a conventional loan term (usually 30 years), and the initial payments begin at the full amortization rate. Over time, the monthly payments increase to cover more principal, and the loan ends up being paid off usually between 15-20 years instead of 30. A Growing Equity Mortgage is something that can be very advantageous and perfect for your situation, but it can also be a major mistake and cause you a lot of problems. A GEM is much like a large brick of gold – it’s very useful if you need money but it’s much more of a hindrance if you’re trying to swim laps. Knowing what situations a GEM is useful for and what situations a GEM would be a crippling burden in is key in making the best decision for your VA home loan.
Growing Equity Mortgages are the best at what they do, which is saving a borrower money in the long term. You can nearly always save more in the long run with a GEM than with any other kind of loan. It’s pretty common for homeowners to do their best to pay a little extra on their monthly mortgage to cut a little more into the principal; this saves the borrower a significant amount on interest over the lifetime of the mortgage. A GEM does a similar thing but on a schedule, and usually adds more onto the monthly payment than most homeowners would on their own. Considering that on a 30-year $300,000 mortgage with a 7% interest rate, a borrower would pay over $400,000 in interest over the course of the loan, cutting that amount down as much as possible would definitely be considered a major pro of the GEM. But before you let the idea of saving $200,000 sweep you away to the heavenly silver-lined clouds of fantasy, here’s the first and biggest con to a GEM, which ironically is how the first major pro of the GEM comes to be.
A GEM saves you money because it mandatorily increases the monthly payment over time, sometimes every single month, depending on the schedule and how the increases are determined. On the $300,000 mortgage above, a fully-amortizing payment is just under $2000/month. If you were to open a GEM on that mortgage, your first payments would be $2000/month, and those payments would gradually get larger and larger to cover more of the principal with each payment. These increases will usually lead to a significantly larger monthly payment by the end. It’s not unheard of for a monthly payment to be doubled by the end of a GEM, which is all well and good as long as you can afford it. But the increasing monthly payments definitely mean tighter wallets and less available spending money.
Because of the way a GEM works, you’ll be able to pay off the mortgage much faster. This is another major advantage of GEMs. How nice would it be to have your home paid off in 20 years instead of 30? Your kids are starting to move out to go to college and you just paid your last house payment. Can you say home theater? How about 2014 Dodge Charger? Two-week vacations to Europe? The world is your oyster if you suddenly find yourself with thousands of dollars more disposable income each month than you had previously. Plus, as you get older and your children find their own homes, you’ll find that you need a lot less room than you used to, and you can sell your home and pocket the entire amount for a smaller home with plenty left over. Imagine paying cash for a nice $150,000 home in a quiet suburb and having another $200,000 sitting in the bank waiting to be spent however you see fit. Definitely a major pro to a GEM.
The next big con of a GEM is that the monthly payments are non-negotiable. In other words, once you sign on to a GEM and agree to the terms, you are financially obligated to pay the minimum monthly payment – even if it is double the amount you were paying at the beginning. This can be very problematic for someone who was expecting to have a significant increase in income but didn’t get it. Many people open a GEM because they anticipate that within 5 years or so, they’ll get a promotion at work and be making significantly more. While we hope that these people get what they’re expecting, it doesn’t always happen that way, and being locked into a GEM can be the chain that drags you into foreclosure if you’re not careful. Don’t let that scare you, just make sure that if you open a GEM that you have a plan B and a plan C in case plan A doesn’t work out.