A graduated payment mortgage or GPM is ideal for young or first-time homeowners. The mortgage payments gradually increase, usually between 7% to 12% annual from the initial payment, until the full monthly payment is reached. Ideally, your income will also increase to match the increased monthly payments.
A GPM begins with low initial payments that increase each year. The interest rate on your GPM is fixed, whereas your payments increase by a percentage each year.
This stair-step payment schedule may be a negative amortization loan. The low initial payments do not cover the interest on the loan. Negative amortization is the difference between what the borrower initially pays and the actual interest on the loan. As a result, the interest is deferred and adds to the total principal of the loan. This is why borrowers end up paying more than compared to conventional mortgages.
For example, if you take out a $200,000 GPM at 6.5% interest, your initial monthly payment is $941. Every year, the payment rises by 7.5%. Therefore, the next year, your monthly payment would be $1,012. The following years’ monthly payments would be $1,087, $1,169, $1,257, and $1,351. After these five consecutive years, the interest rate will have leveled out. Your monthly payment will stay at $1,351 for the duration of the loan term.
Graduated payment mortgages allow borrowers the chance to be a homeowner earlier than compared to some conventional mortgages. This is because this mortgage has a lower interest rate in the beginning. This initial lower monthly payment allows borrowers to qualify for a home mortgage. If the interest rate was higher, such as in a conventional mortgage, these borrowers may not have qualified for a loan.
GPMs are best for buyers with a stable job and room to grow in their career. As you move up in your career field, your income will also increase. As you grow, so will your mortgage payments.
With a GPM, all you know is that your bills will increase over time. It is difficult to predict precisely how much you will earn in the future. As a result, there is a measure of risk and uncertainty if you can afford the future mortgage payments. Furthermore, when you are locked into this type of mortgage, changing careers or jobs can be more difficult.
Mathematically, the costs of a GPM are higher than a traditional mortgage because of the deferred interest payments.
Although your payments change with a GPM, this type of mortgage is different from an adjustable rate mortgage.
GPMs have a fixed interest rate whose monthly payments increase over time. It will continue to increase until the payment levels out to match the interest rate. On the other hand, adjustable rate mortgage’s or ARMs, have different mortgage payments because the interest rate changes to reflect the market. In fact, it is possible for your interest rate to decrease because of market factors. However, GPMs’ will only increase.