PAMs are so structured that the repayments resemble traditional mortgages from the lenders' point of view and resemble GPMs from the borrowers' point of view. This is achieved as follows:
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Under PAMs some portion of the down payment as required under a traditional mortgage is deposited in a savings account.
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The borrower then pays installments which are lower than those under traditional mortgage. These installments are increased at a specified percentage for a definite number of years and thereafter the borrower pays equal installments. Thus, for the borrower the payments resemble a GPM.
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The lender is, however, paid equated monthly installments by drawing the difference between the installment paid by the borrower and the installment due from the pledged savings account.
The difference between payments under traditional mortgage and under a PAM is explained below with the help of an illustration.
Assume that a loan is borrowed for an amount of $110,000 for 30 years at an interest of 10% per annum. The down payment required is $17,535.
Under a traditional mortgage, the borrower would pay the down payment of $17,535 and make an equated monthly payment of $811.46.
Under a PAM mortgage, the structure would be as follows:
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The borrower would make a down payment of $10,000 and deposit $7,535 in a pledged savings payment. Let us assume that this deposit earns an interest of 5¼%.
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The borrower would make graduated payments for 6 years increasing at a rate of 6% every year, and thereafter up to the 30th year the payments would be equated.
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The lender would receive an equated monthly payment of $877.58 throughout the term of the mortgage.
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The gap between the amount payable to the lender and payment made by the borrower will be made up through withdrawals from the pledged savings account.
The amount of payment by the borrower and the amount drawn from the savings account for each year are given below:
Table 4
|
Year(s)
|
Graduated Monthly Payment made by Borrower ($)
|
Amount Drawn from Savings Account ($)
|
Payment made to Lender ($)
|
|
1
|
655.78
|
221.80
|
877.58
|
|
2
|
695.12
|
182.46
|
877.58
|
|
3
|
736.84
|
140.74
|
877.58
|
|
4
|
781.04
|
96.54
|
877.58
|
|
5
|
827.90
|
49.68
|
877.58
|
|
6-30
|
877.58
|
-
|
877.58
|
PAMs are used by borrowers who have sufficient cash on hand, but face an income or cash flow shortage for the first few years. With the cash on hand the pledged savings is opened, as it subsidizes the monthly payment and lowers the cash outgo.