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Graduated payment mortgages are relatively unusual. They have fixed rates, but varying monthly payments. You’ll pay off the balance by the time the loan’s term is over, though it may fluctuate over the course of the loan’s life.
Graduated payment mortgages (GPMs), though uncommon, can be advantageous for certain types of borrowers.
Here’s what you need to know.
What is a graduated payment mortgage?
Mortgages are typically split into two categories: those with fixed rates and those with adjustable rates. A loan with a fixed rate and graduated, or variable, payments is referred to as a graduated payment mortgage.
GPMs are self-amortizing loans, which means that at the end of the loan term, the debt is fully repaid. Usually an FHA product (also known as a Section 245 loan), they demand upfront and ongoing mortgage insurance premium payments from the borrower. FHA GPM plans include:
GPMs are one option for borrowers who anticipate higher earnings in the future but are finding it more difficult to meet the debt-to-income requirements to qualify for a loan today because of the way the payments are structured.
How do graduated payment loans work?
Let’s first take a look at a typical fixed-rate mortgage to better understand how graduated payment mortgages function.
A $200,000 fixed-rate mortgage, for example, with a 2. Loan principal and interest payments are fixed at $832 per month at a 9% interest rate over 30 years. Over the course of the loan’s term, this consistent monthly payment will pay off the entire balance.
A GPM works differently. Say that same $200,000 mortgage, with a 2. The monthly payment will now increase by 5% every year for the first five years with a 9 percent fixed interest rate over 30 years. The loan then converts to fixed monthly payments for the remaining term in year six.
| Year | Monthly payment (Interest + principal) | Balance |
|---|---|---|
| 1 | $673.62 | $197,685.94 |
| 2 | $707.30 | $194,894.31 |
| 3 | $742.66 | $191,590.65 |
| 4 | $779.80 | $187,738.24 |
| 5 | $818.79 | $183,298.46 |
| 6 and beyond | $859.73 |
This GPM example comes with a monthly payment of $673 as opposed to our conventional fixed-rate mortgage scenario, which has a fixed monthly payment of $832 for the life of the loan. 62 in the first year. That’s a cash difference of $158. 38 per month, or $1,900. 56 for that year.
However, by year six, the monthly payment had risen to $859. 73, or $27. 73 more than the $832 payment in the typical fixed-rate scenario is made each month.
Although the mortgage will be paid off in 30 years in both cases, the borrower with the GPM will pay less in interest over the course of the first five years than he would have if he had chosen a standard fixed-rate mortgage.
Pros and cons of graduated payment mortgages
Graduated payment mortgages can be very complex, making it initially difficult to comprehend how they function. But there are advantages, like lower upfront costs, that certain borrowers may find useful.
Graduated payment mortgages and negative amortization
Depending on how high the interest rate is, a mortgage with graduated payments may also amortize negatively. (Negative amortization is a fancy term that means the loan balance could increase rather than decrease.) This occurs when the total interest payment exceeds the initial monthly payment.
Consider once more having a $200,000, 30-year GPM at a 5 7 percent fixed interest rate, with the first five years’ monthly payments rising by 5 percent annually.
The loan balance increases in year one because the interest payment is higher than the monthly payment.
| Month | Monthly payment (Interest + principal) | Interest | Principal | Balance |
|---|---|---|---|---|
| 1 | $949.40 | $950.00 | -$0.60 | $200,000.60 |
| 2 | $949.40 | $950.00 | -$0.60 | $200,001.20 |
| 3 | $949.40 | $950.01 | -$0.61 | $200,001.81 |
| 4 | $949.40 | $950.01 | -$0.61 | $200,002.42 |
| 5 | $949.40 | $950.01 | -$0.61 | $200,003.03 |
| 6 | $949.40 | $950.01 | -$0.61 | $200,003.64 |
| 7 | $949.40 | $950.02 | -$0.62 | $200,004.26 |
| 8 | $949.40 | $950.02 | -$0.62 | $200,004.88 |
| 9 | $949.40 | $950.02 | -$0.62 | $200,005.50 |
| 10 | $949.40 | $950.03 | -$0.63 | $200,006.13 |
| 11 | $949.40 | $950.03 | -$0.63 | $200,006.76 |
| 12 | $949.40 | $950.03 | -$0.63 | $200,007.39 |
However, by year two, the monthly payment will have risen by 5% to $949. 40 to $996. 87. This has surpassed the interest payment, which was $950 at the start of the second year. 04, and the remaining amount is now being paid down rather than being negatively amortized.
Early in the loan term, negative amortization may occur for a number of years, but the mortgage will be structured so that the entire balance will still be repaid by the end of the term. However, because the loan principal increases at the beginning of the repayment period, the mortgage will end up costing more.
Graduated payment mortgage requirements
There are certain requirements borrowers must satisfy because graduated payment mortgages are frequently FHA-insured. These include:
Adjustable-rate mortgage vs. graduated payment mortgage
Although the monthly payments for an adjustable-rate mortgage (ARM) and a graduated payment mortgage both fluctuate at different times, there is a significant difference between the two.
Typical ARMs have a fixed interest rate for the first three to ten years of the loan. When this time period is over, the interest rate may change based on an index, changing the amount due each month. Future payments may increase or decrease, but the borrower is unsure by how much.
Contrarily, a GPM changes the monthly payment, but the borrower is aware of these changes beforehand because of the loan’s repayment schedule. In other words, there aren’t any unexpected price hikes or sticker shock.
The borrower who anticipates significantly higher earnings over the next five to ten years will benefit from a graduated payment mortgage the most despite its peculiar features.
Despite having lower monthly payments up front, these loans typically cost more than a conventional fixed-rate mortgage, especially if they initially amortize negatively. The borrower must pay FHA mortgage insurance premiums because GPMs are also insured by the FHA, which raises the overall cost.
FAQ
What is the meaning of graduated payment mortgage?
A fixed-rate mortgage with graduated payments (GPM) has an amortization schedule that starts with lower payments and gradually increases them over time. A GPM enables homeowners to begin with lower monthly mortgage payments in order to help some people qualify for their loans.
Who qualifies for a graduated payment mortgage?
Graduated Payment Mortgages are FHA loans for homebuyers whose current incomes are low to moderate but who anticipate significant future income growth.
What is the difference between the graduated payment mortgage and a growing equity mortgage?
Due to the similarities in how these two loan types operate, they are frequently confused. However, a graduated-payment mortgage produces negative amortization because it permits the borrower to pay less than the required amount, in contrast to a growth equity mortgage where payments increase over time.
Is a graduated payment mortgage an adjustable rate mortgage?
A loan with a fixed rate and graduated, or variable, payments is referred to as a graduated payment mortgage. GPMs are self-amortizing loans, which means that at the end of the loan term, the debt is fully repaid.