Imagine visiting your doctor due to a painful knee. Your doctor, who just happened to be a cardiologist by trade, enters the exam room and, after examining your knee, writes you a prescription for high blood pressure medicine. “Doc,” you ask as your gaze shifts between the doctor and your knee, “Why are you prescribing me medicine for high blood pressure when my blood pressure is fine? It’s my knee that’s bothering me.” Can you imagine your reaction if, in response to that, the doctor replied, “Well, I’m a cardiologist. I really don’t know a lot about knees or the human skeletal system. And I need to treat you for something, or I won’t get paid!”?
Obviously, an interaction such as this would be absurd. Any doctor who acted in this manner would be quickly deemed incompetent and, most likely, find himself at the ugly end of a malpractice lawsuit. The doctor, if unable to properly and effectively treat his patient, would be expected to refer the patient to a more suitable provider.
As the “Mortgage Doctor,” the mortgage loan originator is legally charged with the fiduciary responsibility of always acting in the best interests of his or her clients. Even if that means referring the client to a different provider who can offer that client a more suitable solution than what he or she can offer and losing the commission. Recognizing what’s in the customer’s best interests, however, is akin to a physician being able to accurately diagnose his or her patient. Or, at the very least, it’s knowing when to refer one’s patient to a different health care provider with more expertise in that patient’s particular ailment.
Being able to accurately identify what’s in the mortgage customer’s best interests not only requires thorough diagnostic skills, but an extensive knowledge of all available mortgage programs, even those to which the MLO does not have access or offer. Two such uncommon mortgage programs that might prove to be a borrower’s best solution are the Growth Equity Mortgage (GEM) and the Graduated Payment Mortgage (GPM).
The Growth Equity Mortgage (GEM)
The Growth Equity Mortgage is the FHA 245(a). This financing option may prove to be the ideal selection for the borrower desiring to repay his or her mortgage loan as soon as possible but lacks the financial discipline necessary to independently remit regular principal pre-payments.
The GEM offers a fixed interest rate but begins requiring a higher payment than what would be otherwise due if the loan amortized over 360 months. At pre-defined times, the periodic payment amount due increases and, with all payments, the difference between the standard 30-year fixed-rate payment and the payment amount received is applied directly against the loan’s principal balance. By simply remitting the periodic payment amount due, the borrower ultimately saves interest and builds equity quicker by repaying their loan faster than through the standard 30-year amortization. It is absolutely critical, however, that the borrower understands exactly how much the future periodic payments owed will be and is able to qualify based on the highest payment that will be required over the loan’s life. And this has to be considered along with the escrow payment which will typically increase over time.
Let’s consider the following example:
A borrower is issued a $350,000 mortgage at 4.25% fixed. The 30-year principal and interest payment amount, corresponding to these terms, would be $1,721.79. For the loan’s first five years, however, the borrower is billed $1,875.50. When the borrower remits this payment amount, the $153.71 difference gets automatically applied against the loan’s principal balance as a principal pre-payment. After five years, instead of his balance being $317,826.91, his balance is $307,571.26.
Starting with the sixth year, the periodic payment due is increased to $2,010.50 leaving a balance owed, at year ten, of $246,109.26.
Starting with year eleven, the periodic payment due is increased to $2,350.45 leaving a balanced owed, at year fifteen, of $147,442.28.
Starting with year sixteen, the periodic payment due is increased to $2,525.00 leaving a balance owed, at year twenty, of $13,813.84.
Starting in year twenty-one, the periodic payment due is increased to $2,810.00, and, as such, in the fourth month of the loan’s twenty-first year, the loan pays in full.
By simply remitting the minimum payment solicited, the borrower pays off his loan almost nine years sooner than he otherwise would have and has saved all of the interest that he would have otherwise spent during those last nine years. Sure, the borrower could have accomplished the same results on his own, but, in lacking financial discipline, this mortgage product proved to be the perfect solution.
The Graduated Payment Mortgage (GPM)
Unlike the former borrower who wanted to accelerate his loan’s payoff, the borrower needing to maximize cashflow may very well find the Graduated Payment Mortgage to be her perfect solution.
The GPM is a fixed-rate mortgage affording the borrower the option of remitting a lower payment amount than would otherwise be required for a specified period of time. It’s important for the borrower to thoroughly understand, however, that this lower payment amount does not sufficiently satisfy the actual interest owed. The difference between each payment and the true amount owed is therefore added to the loan’s principal balance thereby creating negative amortization. At the scheduled graduation date, the payment amount is increased to satisfy the outstanding balance within the loan’s original term. It is critical that the loan originator make the customer aware of what the payment will be at graduation since it can be dramatically higher than the payment to which the borrower was accustomed to paying.
Let’s consider the following example:
A borrower is issued a $350,000 mortgage at 4.25% fixed. The 30-year principal and interest payment amount, corresponding to these terms, would be $1,721.79. If the borrower remitted this payment amount, after ten years, her remaining balance would be $278,051.33. For the first ten years, however, instead of being required to remit $1,721.79, the borrower is only billed $1,100.00. As such, after ten years, the borrower’s loan balance is now $370,826.85 to account for the remitted payments not covering all of the interest that was technically owed.
At year ten, the servicer must re-cast the loan to ensure its amortization to the original 30-year term. Therefore, with a current balance of $370,826.85, at a fixed interest rate of 4.25%, on a remaining twenty-year term (since ten years of the original 30-year term has elapsed), the borrower’s principal and interest payment amount grows from $1,100.00 to $2,296.29. As such, the borrower would have to qualify for the $2,296.29 payment amount when first applying for the loan. The benefit that the borrower received through the GPM, however, was a ten-year cashflow savings of $74,614.80 ($1,100.00 x 120 = $132,000.00 versus $1,721.79 x 120 = $206,614.80).
It all boils down to the borrower’s wants and needs. And the successful mortgage loan originator is able to accurately identify those wants and needs while being able to recognize and offer the appropriate solution to those wants and needs. By knowing about unique mortgage products such as the Growth Equity Mortgage and the Graduated Payment Mortgage, the mortgage loan originator moves ever closer to becoming the steely-eyed and revered industry expert who he or she strives to be.