The graduated payment mortgage is poised to make a comeback as borrowers and lenders seek financing solutions that ease the financial strain of buying a home.
You have climbed the ladder of education and, chances are, you're eyeing the corporate ladder, too. If buying a home is also on your radar, there may be one more ladder in store for you-the ladder of graduated mortgage payments.
A graduated payment mortgage, also called GPM, is a specialized loan structure that incorporates low initial payments that increase periodically over time. The GPM is not an adjustable-rate mortgage (ARM); it carries a fixed rate of interest, and the amount by which the payments will increase is also fixed prior to funding. This means no ugly payment surprises. The only thing you have to worry about is working hard and earning your annual raise, so that your income keeps up with the scheduled payment increases.
Nuts and bolts of the GPM
- Interest rate. GPMs have a fixed interest rate, which is likely to be about 0.50 to 0.75 percent higher than the rate on a more conventional mortgage loan.
- Payments. Payment structures vary. Typically, payments increase once annually by a set percentage for the first five to ten years of the loan. Thereafter, payments remain fixed until maturity. The increase is normally between 7.5 percent and 12.5 percent. Assuming a 10 percent annual increase, for example, an initial payment of $1,000 increases to $1,100 in year two, $1,210 in year three, $1,331 in year four, and so on.
- Amortization. GPMs have either 15-year or 30-year maturities. In the early years of the loan, the payment amount won't be sufficient to cover the monthly accrued interest, so the unpaid portion is added into the outstanding balance. This negative amortization process may add up to 10 percent of the opening loan balance. As payments increase, this reverses, so that the loan is completely paid off at maturity.
- Loan amounts. Like traditional mortgages, GPMs are subject to conforming loan limits. In order for a GPM to qualify for Freddie Mac or Fannie Mae guarantee, the loan amount must be less than $417,000. Loans made in excess of this limit are available (jumbo GPMs), but they'll be more expensive.
- Prepayments. Some GPMs assess penalties if you pay off the entire balance within the first five years. You can, however, make larger monthly payments without penalty; these shorten the loan term without affecting future payment levels.
- Cost. The total interest cost of a GPM is higher than a traditional mortgage for the same amount. GPM borrowers accept this trade-off in return for having the ability to buy a home sooner rather than later.
The GPM ladder really only has five or ten rungs. If you can climb those as you work your way up the corporate ladder, the rest is smooth sailing.