Types of Home Mortgages: Graduated Payment Home Mortgage

An Overview of the Graduated Payment Home Mortgage

The graduated payment home mortgage is a payment plan very like the FRM. In fact, it is considered a fixed rate mortgage, but doesn’t have the stable payment amounts, as the name suggests. A graduated payment mortgage starts with low monthly payments that get larger with time, but the payments at the outset are what the lenders use to qualify the buyer. In this manner, a GPM is often used to qualify a buyer who normally may not have qualified for the regular FRM.

Payments on a Graduated Payment Home Mortgage

The payments on a graduated payment home mortgage are based on a fixed interest rate, but the initial payments are lower and made up later. The first payment on a GPM won’t even cover all of the interest. This creates a negative amortization condition, where the interest that is not covered goes back into the loan amount. As the payments rise, this additional money is paid, and eventually the payments rise enough (usually over 5 years) that the amount can be stabilized and the loan paid off in that manner over the remaining term of the loan.

A Look at Alternatives

Often a better alternative for borrowers is the buydown, where you would pay discount points to lower your payments for a certain period of the loan. The payments on a buydown also increase with time, and you wouldn’t have the negative amortization to deal with. It requires money up front, however, and many borrowers are considering a GPM simply because they don’t have a lot of it.

The GPM and the ARM: Similarities and Differences

The GPM also resembles the ARM in that the payments are increased gradually, but the ARM does it by changing interest rates over time. Besides the payments on the ARM being often lower than the GPM, the advantage here is that there are caps on the amount the payment can be raised and several ways to limit it. The benefit to the GPM against the ARM, however, is that the GPM is a fixed rate. The rate on the ARM goes, and can continue to go, up.

Final Notes and Considerations on the GPM

Although there are inherent risks in the GPM, its fixed rate is an attractive way to limit payment increases. Also, the buyer will know how exactly much the payments will increase and when, where the ARM borrower only knows when. The borrower with the GPM, however, also needs to be ready for the increases and plan ahead, as well as understand how the negative amortization in the beginning of the loan will affect the future.