Alternative Mortgage Instrument - Explained
What is an Alternative Mortgage Instrument?
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Table of ContentsWhat is an Alternative Mortgage Instrument?How does an Alternative Mortgage Instrument Work?Timeline of Alternative Mortgage InstrumentsIllustration of an Alternative Mortgage Instrument
What is an Alternative Mortgage Instrument?
An Alternative Mortgage Instrument (AMI) is any type of non-conventional mortgage agreement that does not specify a fixed interest rate or an amortization schedule or the terms of repayment. The following are a few examples of Alternative Mortgage Instruments:
- Adjustable Rate Mortgage (ARM)
- Shared Appreciation Mortgage (SAM)
- Graduated Payment Mortgage (GPM)
- Growth Equity Mortgage (GEM)
AMIs such as adjustable-rate mortgages and hybrid mortgages are typically secured by real estate.
How does an Alternative Mortgage Instrument Work?
Alternative Mortgage Instruments (AMIs) are usually preferred by investors that are unable to afford regular mortgage because of high interest rates and as such, residential mortgage loans constitute a major chunk of AMIs. Alternative mortgage instruments not only reduce monthly payment installments but also enable borrowers to finance higher prices. It is for this reason that AMIs are widely preferred by middle-class home buyers in their quest for more affordable housing. Besides, AMIs are also popular among larger groups of investors seeking to invest in real estate. Since AMIs are non-fixed interest mortgage loans, they usually involve lower monthly installments in the initial phases compared to fixed interest mortgage loans. However, the interest rate fluctuates over time to reflect changes in the real estate market. In the case of Adjustable Rate Mortgages (ARMs), the interest rate climbs periodically. Similarly, a lender of Shared Appreciation Mortgages (SAMs) compensates for the lower initial interest rate by subsequently raising it in keeping with appreciating property value. In case of Graduated Payment Mortgages (GPMs), the mortgages carry average interest rates, but differ in the installment amounts. Lenders offering such mortgage loans usually raise the interest rates after a specified period. Growing equity mortgages (GEMs) are similar to graduated payment mortgages wherein the installments gradually increase over time. However, unlike GPMs, GEMs earn money by depositing the excess payment into a retirement fund for the borrower.
Timeline of Alternative Mortgage Instruments
Alternative Mortgage Instruments (AMIs) first rose in popularity in the early 1980s as viable alternatives to conventional mortgage loans that usually commanded high interest rates. The lower mortgage payments associated with AMIs, in a way, revolutionized the housing market by making mortgage loans accessible to several first-time homebuyers. Alternative Mortgage Instruments also made it possible for homebuyers to finance more expensive properties. The first five years of the new millennium saw a significant drop in interest rates, which directly resulted in record home sales. As a result, banks and other financial institutions introduced more Alternative Mortgage Instruments (AMIs) with added features such as lower down payments and up to 100 percent financing. Besides, the period from 2001 to 2005 saw the emergence of AMIs with longer-term amortization schedules, variable-rate mortgages, graduated-payment mortgages, and reverse-annuity mortgages.
Illustration of an Alternative Mortgage Instrument
Suppose, the Andrews are looking to purchase their first home for $300,000. Being unable to afford a standard 30-year fixed-rate mortgage, the family instead settles for an Adjustable Rate Mortgage (ARM), specifically a 5/1 ARM. A 5/1 Adjustable Rate Mortgage has a fixed rate for the first five years and then transforms into an adjustable-rate mortgage for the remaining term. Now, the Andrews home is expected to increase in value during the first five years. This provides the family the opportunity to switch to a more conventional fixed rate mortgage loan before the ARM payments increase.