Leverage is a term used in real estate finance defined as using a small amount ownership to pay for a much larger ownership. When used in moderation, this method for purchasing real estate is brilliant.
Unfortunately, when people use leverage programs in an extreme way, it’s likely to cause big trouble for mortgage buyers. With that warning about overdoing your property purchases through leveraging, I want to discuss several types of leveraged buys that might work for you.
Each one of these home buying options is designed for a specific type of borrower. While the GEM might be perfectly suited for a young husband and wife, it would be a perfect disaster for an older couple. While the RAM might make excellent sense for a pair nearing retirement, it wouldn’t even be possible for most younger people.
In each case, leverage is used to extract the most value out of the mortgage possible, while letting you place the burden of paying back the loan at just the right time for you and your spouse.
Growing Equity Mortgage
The growing equity mortgage or GEM is a 20-year to 30 year mortgage which starts off with low monthly payments. As the years pass, the mortgage payment increases somewhere between 3% and 7.5% per year. As time goes by, the GEM begins to pay off the principal, so that the mortgage is often paid off in 12 to 13 years.
The GEM plan is meant for people who can’t pay much now, but have good prospects of paying bigger money later. This works for young professionals just out college who should rise rapidly in their career, but might have large debt from the student loan process or starts out at a low wage. Others this is tailor made for include first-time home buyers who need help qualifying, or young married couples with expenses from weddings or childbirth.
Graduated Payment Mortgage
Graduated payment mortgages are a little bit like the GEM in that they start out low and graduate to higher payments in later years. But where the GEM continues to grow over the life of the mortgage, the GPM grows over a 5 to 10 year period and then becomes a fixed mortgage.
The one tricky part of the GPM is that interest doesn’t change over time. This means that interest is high from the get-go, so you might end up having more interest added to the loan than you pay off in the early years. In other words, you might have negative amortization. The house payment might put you more in-debt for a time, but it’s wiped out later in the contract.
The GPM loan works for people who can expect a steady, dependable increase in their salary; who plan to be in a home over a long period of time (thus they aren’t reselling the home for less than you owe); for properties in which the property value is expected to increase over the next 5-10 years; who require jumbo loans; or who should have the ability to refinance at a later time. If one of these options applies to you, the GPM might work for your family’s needs and necessities.
Reverse Annuity Mortgage
Imagine you’re a 62 year old who’ll soon be retiring and who paid for your home off a decade ago, but who doesn’t have a lot of money invested for retirement. Then imagine you want to sell your house to pay for your post-career senior years, but you can’t think of leaving your house and don’t see the benefit from renting while you sell the homestead.
The reverse annuity mortgage is an “equity release” program meant for you.
When you take out an RAM, you receive a loan in exchange for the equity on your house. At the same time, you get to remain living in the same house while receiving payments in the form of a credit line account, a monthly cash advance, a flat sum payment per month, or some combination of all of these offers. One stipulation is this must be the primary home of the mortgagors and the mortgage program is paid out on one home only.
The most familiar RAM loan are those offer by the Home Equity Conversion Mortgage you’ll find offered by HUD and the Homekeeper Mortgage offered by Fannie Mae. The HECM loan is FHA insured. The loan doesn’t have to be paid back as long as you continue to live in the residence. As soon as the last living resident dies, moves away permanently, or sells the home, the full amount of the loan and its interest must be paid. This means the estate of a person also goes to pay off these loans.
Using Leveraged Lending Programs
These are just three of the ways to use leverage in a home to give you more options for buying or using the property fully. Each program is designed for specific types of home owners. These might be perfectly awful ideas for most homebuyers, but if you fall into one of the mortgage borrower categories described above, these leveraged loan programs might be perfect for your budget situation.