What Is a Growing-Equity Mortgage?

Article Summary:

A growing-equity mortgage (GEM) is a type of loan where the interest rate is fixed but the monthly payments increase every year throughout the loan term. This mortgage variation allows you to pay off your loan faster than with a conventional 30-year home loan, and to save money on interest.

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.

A word about the “reasonable expectation” requirement. Have you ever read a company annual report or looked over an investment prospectus? The standard for these documents is a “forward-looking statements” caveat. In case you haven’t seen one before, here is a classic from the Royal Bank of Canada:

By their very nature, forward-looking statements require us to make assumptions and are subject to inherent risks and uncertainties, which give rise to the possibility that our predictions, forecasts, projections, expectations or conclusions will not prove to be accurate, that our assumptions may not be correct and that our financial performance objectives, vision and strategic goals will not be achieved.”

Consider taking this kind of caveat to heart before choosing a mortgage based on forward-looking statements about your income. Being in a growth industry helps, but be aware that not every employee in a growth industry grows as rapidly or reliably as the industry. Try to work through some realistic probabilities and multiple future scenarios, even worse-case ones, before you commit. And make sure you look at a variety of mortgage options, not just GEMs.

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

GEM Pros & Cons

Here is a list of the benefits and the drawbacks to consider.

  • Lower down payment. By their very nature, GEMs attract buyers who don’t make a lot of money now but expect to in the future. Because of this, and because it’s a higher-risk mortgage, requirements are more lenient than getting approved for a traditional home loan, which includes smaller down payments.
  • Flexible eligibility requirements. In addition to a lower down payment, a buyer doesn’t need to have the most amazing credit score or a particularly large salary to be considered for a GEM. The lender is banking — literally — on your income to increase right along with those higher monthly payments.
  • Saves you money on interest. Because you are essentially paying off a 30-year mortgage in 15–20 years, you are going to save a substantial amount of money on interest payments. Every time your payment increases, that sum goes directly toward the principal. So you start saving money on interest as early as your second year into the loan, while lowering your principal balance.
  • Accumulate equity faster. As your payments increase and your principal decreases at the same time, you are building equity much more quickly than you could with a traditional mortgage. It can be very convenient to have that money handy if you ever need it. Plus, if you get a home equity loan, you can deduct the interest from that on your taxes.
  • Payments increase every year. Here’s the catch. And it’s a big one. Your monthly mortgage payments will grow every single year until that loan is paid in full. It might not seem like a big deal in the first few years, but pretty soon you’re looking at a substantial mortgage payment, and it’s only going to get bigger. If something goes wrong — your career falls through or you get sick or injured — you could find yourself in foreclosure. You need to take care with “forward-looking statements,” remember.

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.

This loan in history. GEMs are not a new product in the world of HUD-administered FHA loans. One agency memo on the topic dates back to 1985.

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.

You can learn more about these loans and how to qualify for them here and here.

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.


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.

Key takeaways

  • The GEM loan program is a faster way to build equity, save thousands on interest, and pay off your home.
  • Individuals with high income potential are good candidates for this type of loan.
  • Monthly mortgage payments will increase annually throughout the loan term.
  • GEMs come with really high monthly payments over time.
  • Growing-equity loans have more flexible credit requirements than conventional mortgages.
View Article Sources
  1. Basic Home Mortgage Loan 203(B) — U.S. Department of Housing and Urban Development (HUD)
  2. Caution regarding forward-looking statements — Royal Bank of Canada
  3. Mortgagee Letter 85-3 on the Subject of Growing Equity Mortgages (GEMs) — HUD
  4. Pathways to Home Ownership Unit 6 – 4: Finding the Right Mortgage for You — Kentucky Real Estate Commission & Northern Kentucky University
  5. What is negative amortization? — Consumer Financial Protection Bureau
  6. A Complete Guide to Down Payment Assistance — SuperMoney
  7. A Complete Guide To Home Mortgage Foreclosure — SuperMoney
  8. Best Mortgage Lenders — SuperMoney
  9. Best Personal Credit Cards — SuperMoney
  10. Buying a House? Here’s How to Choose the Best Mortgage Lender — SuperMoney
  11. Home Equity Lines of Credit: Reviews & Comparisons — SuperMoney
  12. Best Mortgage Refinance Lenders — SuperMoney
  13. Home Equity Loans: Reviews & Comparisons — SuperMoney
  14. Money Market Accounts: Reviews & Comparisons — SuperMoney
  15. Mortgage Industry Study — SuperMoney
  16. Savings Accounts: Reviews & Comparisons — SuperMoney
  17. The Definitive Guide to FHA Loans — SuperMoney
  18. What is a 3/1 ARM and is It a Good Idea? — SuperMoney
  19. What Is a Graduated Payment Mortgage? — SuperMoney