What Is a Growing-Equity Mortgage?

There are so many different kinds of mortgages, it can be tough to decide which is the right one for your unique circumstances. If you plan on paying the loan off quickly or selling within a few years, for example, you might consider an adjustable-rate mortgage (ARM). But that is not an option for many people.

Here’s another scenario. Maybe you are in a growing industry and expect your salary to increase rapidly in the next several years. But you’re not there yet, and you want to buy a house now. In that case, you might want to think about a growing-equity mortgage (GEM). This can be a great opportunity to get the house now, and more aggressively pay for it later, as your income escalates.

What is a growing-equity mortgage (GEM)?

A growing-equity mortgage (GEM) is a type of loan where the monthly payments gradually increase over the years. It’s a variation of a fixed-rate mortgage, and it allows you to accumulate equity faster, pay off your mortgage more quickly, which could save a ton of money in interest.

GEMs are typically for individuals who, though they don’t have high-paying jobs yet, expect their salary to increase fairly rapidly to go along with the growing mortgage payments. They’re designed to allow someone to buy a house right away who otherwise might not be eligible based on factors such as current income.

Growing equity mortgages (GEMs) are designed for borrowers who want to pay the loan off early by having the equity in the loan grow as fast as possible.

The young professional who chose a GEM

Let’s say you are a young, first-time home buyer fresh out of law school with your first job as a junior associate. You might not have a great credit score or a very high income yet, but you want to buy a house now. Because of the nature of the industry you’re in, you can reasonably expect promotions and hefty salary increases within a relatively short period of time. This makes you an ideal candidate for a growing-equity mortgage, and a fairly acceptable risk for a lender to take.

Many traditional lenders offer a growing-equity mortgage program for borrowers who show a reasonable expectation of significant salary growth. The Federal Housing Administration (FHA) also has such a program, and it often requires only a 3.5% down payment and has even less-strict eligibility requirements than conventional lenders.

How to shop for growing-equity mortgages

Mortgage lenders will rarely advertise whether they offer growing-equity mortgages as an option. Instead of investing too much time and energy in searching for lenders that specialize in growing-equity mortgages, focus on finding the lender that offers you the best deal. Once you find the lender that provides the best rates and terms, ask if growing-equity mortgages are an option. If a growing-equity mortgage is an option, consider which mortgage type works best for you.

How growing-equity mortgages work

With a conventional 30-year mortgage comes a fixed interest rate and a monthly payment that is the same every month. Growing-equity mortgages, on the other hand, also have a fixed interest rate, but payments grow incrementally every year for the life of the loan. Typically, these types of loans are paid off within 15–20 years.

The increase is usually anywhere up to 5% annually, depending on how quickly you want to pay off the loan in full. In the first year, your initial payments will be the same as if you had a conventional 30-year loan. Every year after that, payments will escalate, and the extra money will go directly toward the principal.

By paying the principal down earlier than normal, you build equity in the home much sooner. Not only does this result in thousands in interest savings, it also puts you in a better position if you want to sell and buy a more expensive house. Plus, because you’re sitting on all that equity, you could get a home equity loan or line of credit if you ever needed to.

Pros and cons of growing-equity mortgages

Who applies for growing-equity loans?

The important question isn’t who applies but who should apply for these loans.

Not ideal for mid-career, salary-plateaued borrowers

Let’s say you’re entering middle age and have a steady job, but you’re not expecting any huge jumps in income anymore. In that case, a loan that comes with increasing mortgage payments is not going to be the right choice for you.

Better for young, and upwardly mobile borrowers, even without great credit

However, if you’re young and just starting out in a high-growth industry, or you’ve changed careers for one that’s more lucrative, a GEM might be a great opportunity. Then, as your mortgage payments grow, your salary should be increasing right along with them.

These loans can be especially good for an individual who fits that basic description, but who also doesn’t have the best credit. A growing-equity loan is higher risk, so the standards for approval aren’t so stringent. The FHA has options for loans that allow for less-than-stellar credit scores and, in addition to not requiring you to put as much down as you would on a conventional loan, may include down payment assistance.

What are the risks of a growing-equity mortgage?

The biggest risk is that something goes wrong and you find yourself unable to make your mortgage payment. If you lose your job (or there’s another pandemic) you might find yourself with an unmanageable bill and wind up having to sell your house or, worse, end up in foreclosure. This is why you need to be pretty sure of your prospects before undertaking a growing-equity mortgage.

Consider an emergency fund

One way to mitigate that risk is to have a substantial emergency fund to get you through the hard times. This might mean making a smaller down payment. Sometimes having that extra cash in the bank can be more valuable than an excess of equity in your home. It’s more liquid, for one thing, which can be very helpful in an emergency. It could take time to take out a home equity loan or a home equity line of credit, and depending on the circumstances, you could be denied. Cash in your savings or money market account can be accessed today.

Alternatives to growing-equity mortgages

Conventional fixed-rate mortgages

Conventional financing programs are the most traditional and conservative way to go when you need a home loan. They come with a consistent monthly payment throughout the life of the loan — unlike GEMs — and can be easier to fit into your budget. Plus, if you want to pay your loan off early, you can always make additional payments whenever you have the extra cash. Just make sure your lender doesn’t charge a prepayment fee.

It’s important to note, though, that this loan carries stricter requirements for credit score, income, and personal cash investment, which can put it out of reach for some buyers.

FHA 203(b) Loans

This option can be a great alternative to a growing-equity loan, because the requirements for loan approval are even more flexible. These loans are great for first-time buyers and those without a sizable down payment or a great credit rating.

The loan program offers 15- and 30-year mortgages and accepts down payments of as little as 3.5% of the purchase price with a credit score of 580 or higher. (Credit scores lower than that may have to put up 10%.) The downside is that you will have to pay an upfront mortgage insurance premium (MIP) as well as a monthly MIP as part of your total mortgage bill. This can cut into what a buyer might be able to afford.

Graduated-payment loans

Not to be confused with a growing-equity loan, a graduated-payment mortgage is very different. The only similarities are increasing monthly payments and fixed interest rates.

But in the case of graduated-payment loans, you start at a very low, essentially an interest-only, payment that gradually goes up until it reaches the full mortgage payment (aka, the fully-amortizing payment).

Because you are making a low monthly payment of interest only at the beginning of a graduated-payment mortgage, you sometimes end up with negative amortization. This grows the principle and ends up costing you more in interest. (More on negative amortization to follow.) By contrast, a GEM starts at the fully-amortized payment and goes up from there throughout the life of the loan, which will save you a lot on interest.

FAQ

What is the advantage of a growing-equity mortgage?

As your career takes off, you expect to make more money, but that doesn’t happen overnight. If it does, lucky you, but failing that, the big advantage is being able to start at a manageable monthly mortgage payment. Eventually, as your career progresses and your salary increases, you can make those higher payments as they come. This then allows you to more rapidly pay down the principal, save on interest, and build equity in the home.

What is another name for a growing-equity mortgage?

Growing-equity mortgages (GEMs) are also known as growing-equity loans, growth-equity mortgages, and growth-equity loans. The terms are interchangeable. They all refer to the same growing-equity mortgage program, which allows the buyer to start out with a low monthly payment that increases over time. The borrower’s goal with a GEM is to pay off the loan and build equity more quickly, and to save thousands of dollars in interest.

Do mortgage payments decrease as equity increases?

Your mortgage payments will never go down in a growing-equity mortgage. They will increase annually for the life of the loan until it’s paid off. But the excess after the first-year fully-amortized payments goes straight to the principal, allowing you to pay off your loan sooner.