Most borrowers are aware of fixed rate and adjustable rate mortgages, but not many have heard of graduated payment mortgage.
Which is a shame, because it can save you a fortune.
This kind of mortgage presents another alternative for borrowers looking for a mortgage loan product to fit their needs.
With a graduated payment mortgage, the payments start out being low and rise over time. When the loan officer qualifies the borrower for a graduated payment mortgage, the initial (low) payment is used. This usually allows the borrower to qualify when he might not qualify for a fixed-rate mortgage.
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How it Works
Similar to a fixed-rate mortgage, the graduated payment mortgage has a fixed interest rate for the life of the loan. The payments on the graduated payment mortgage start out at a certain level and increase periodically by a percentage for a specific period of time.
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For example, monthly payments on a $100,000 graduated payment mortgage might start out at $900 and increase by 7% every year for 5 years. After five years, the graduation is complete and the payments are fixed for the remainer of the loan.
During the graduation period, the graduated payment mortgage the monthly payments are not high enough to cover the interest on the mortgage. This causes a negative amortization. At the end of each year, the unpaid interest is added back to the loan causing the balance of the loan to increase.
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The good news is that at the end of the graduation period, your payments begin to cover both the principle and the loan, thereby decreasing your balance.
GRM vs ARM
Graduated payment mortgages are often compared to adjustable rate mortgages because of the variation in payments over time. However, these two loan products differ greatly in many aspects. For one, the graduated payment mortgage has a fixed interest rate meaning the interest rate does not change for the life of the loan. With an adjustable rate mortgage, however, the interest rate does change.
The scheduled payments for a graduated payment mortgage are calculated in advance. On the other hand, payments for an adjustable rate mortgage can vary from one time period to the next depending on the terms of the loan.
Who Might Benefit
First-time homebuyers who are just starting out in their careers are ideal candidates for graduated payment mortgages. Since first-time homebuyers typically do not have high incomes, a graduated payment mortgage option makes it easier to qualify for a home loan.
In addition, those who are new in their careers typically expect to have pay increases over time which allow them to predict the ability to make the graduated payments.
Potential Risks
A borrower with a graduated payment mortgage runs the risk of overestimating their future earning potential making it difficult to afford the mortgage in the future.
If the homeowner sells the home before the loan begins to amortize, he runs the risks of losing money on the home, especially if it devalues during that period of time.
As with any other loan product, a borrower should assess both the benefits and the risks of a graduated payment mortgage before making a decision.
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A Graduated Payments Mortgage Can Save You A Fortune