3. Growing-Equity Mortgages (geMs)

Growing-Equity Mortgages (GEMs) Lenders designed the growing-equity mortgage loan to help the borrower pay off the loan in a shorter period of time. With a GEM, the payments will initially be the same as on a conventional mortgage. However, over time the payment will increase. This increase will reduce the principal more quickly than the conventional payment stream would. For example, a typical contract may call for level payments for the first two years. The payments may increase by 5% per year for the next five years, than remain the same until maturity. The result is to reduce the life of the loan from 30 years to about 17.

GEMs are popular among borrowers who expect their incomes to rise in the future. It gives them the benefit of a small payment at the beginning while still retiring the debt early. Although the increase in payments is required in GEMs, most mortgage loans have no prepayment penalty. This means that a borrower with a 30-year loan could create a GEM by simply increasing the monthly payments beyond what is required and designating that the excess be applied entirely to the principal.

The GEM is similar to the graduated-payment mortgage; the difference is that the goal of the GPM is to help the borrower qualify by reducing the first few years’ payments. The loan still pays off in 30 years. The goal of the GEM is to let the borrower pay off early.

4. Shared-Appreciation Mortgages (saMs) and Equity Participation Mortgages

Shared-Appreciation Mortgages (SAMs) When interest rates are high, the monthly payments on mortgage loans are also high. That prevents many borrowers from qualifying for loans. To help borrowers qualify and to keep loan volume high, lenders created the shared-appreciation mortgage. In a SAM, the lender lowers the interest rate on the mortgage in exchange for a share of any appreciation in the real estate (if the property sells for more than a stated amount, the lender is entitled to a portion of the gain). As interest rates and inflation fell in the late 1980s and into the 1990s, the popularity of these loans also diminished.

Equity Participation Mortgages In a shared-appreciation mortgage, the lender shares in the appreciation of the property. In an equity participation mortgage, an outside investor rather than the lender shares in the appreciation of the property. This investor will either provide a portion of the purchase price of the property or supplement the monthly payments. In return, the investor receives a portion of any appreciation in the property. As with the SAM, the borrower benefits by being able to qualify for a larger loan than without such help.

5. Second Mortgages

Second mortgages are loans that are secured by the same real estate that is used to secure the first mortgage. The second mortgage is junior to the original loan. This means that should a default occur, the second mortgage holder wall be paid only after the original loan has been paid off, if sufficient funds remain.

Second mortgages have two purposes. The first is to give borrowers a way to use the equity they have in their homes as security for another loan. An alternative to the second mortgage would be to refinance the home at a higher loan amount than is currently owed. The cost of obtaining a second mortgage is often much lower than refinancing.

Another purpose of the second mortgage is to take advantage of one of the few remaining tax deductions available to the middle class. The interest on loans secured by residential real estate is tax-deductible (the tax laws allow borrowers to deduct the interest on the primary residence and one vacation home). No other kind of consumer loan has this tax deduction. Many banks now offer lines of credit secured by second mortgages. In most cases, the value of the security is not of great interest to the bank. Consumers prefer that the line of credit be secured so that they can deduct the interest on the loan from their taxes.