Early in your career, you may have a desire or plan to buy a home, but you may not be able to afford the home you want because of your income level. You can not afford it using some of the conventional mortgage loans. This doesn’t mean that you should quit the idea of buying a home. You have some options available. One such option is the graduated-payment mortgage.
As it was mentioned, one type of mortgage available for purchasing a property is the graduated-payment mortgage (GPM). Depending on your financial situation, maybe you should consider applying for a graduated mortgage payment. This doesn’t mean that you should immediately take out a graduated-payment mortgage. You should make a comparison between the available types of mortgages to see which mortgage is the most adequate for your needs and situation. However, try to understand the pros and cons that come with each type of mortgage. Before we go to the advantages and disadvantages of a graduated-payment mortgage, the mortgage itself should be defined briefly.
So, what is a graduated-payment mortgage (GPM)?
Simply stated, this is a fixed-rate mortgage with increasing monthly payments, which means that there is a predefined schedule regarding the increase of your monthly payments during the life of the mortgage. The repayment of the GPM mortgage starts with a lower monthly payment, and the payment gradually increases for a certain (predefined) period of time. Keep in mind, though, that your monthly payment will not increase during the entire loan life. Instead, it will increase for a set period of time, sometimes referred to as a low introductory rate period. When this period is over, the monthly payment will be fixed until the end of loan maturity. It should be noted that your monthly payment at the end of the introductory rate period will be higher than your initial monthly payment.
The monthly payment can commonly increase anywhere up to 7.5% for a period of up to ten years, depending on the graduated-payment mortgage plans. For instance, on a 25-year loan, you could have a graduated payment schedule for a pre-defined period of five years. Your low initial payment will gradually increase up to year five. At the end of the five years of low introductory rate period, your monthly payment will be fixed at a higher amount for the remaining of the mortgage term. This means that after year five, your monthly payment will not be subject to any additional increases.
This type of mortgage offers some advantages for borrowers who cannot make larger monthly payments when they buy the property. But the new homeowners expect to meet higher monthly payments later because of, for example, an increase in income level.
One of the most important things that should be understood when talking about graduated-payment mortgage is the concept of negative amortization (try to understand loan amortization and loan amortization schedule as well). You should understand this concept because it can be a feature of GPM. Negative amortization appears because the payment itself includes smaller interest payments during the low monthly payment period, which means that the payment is not enough to fully cover the interest due. Thus, the interest due for the period is not paid in full with the lower monthly payment. The remaining interest (a difference between the interest due and interest paid) will be added to the principal amount.
Advantages of graduated-payment mortgage
Ability to purchase a home earlier in your life – may be at the starting of your career you cannot afford to buy a home because of the lower-income level. Thus, a GPM mortgage can be used to overcome this problem. Because you will have a lower initial monthly, you can qualify for a mortgage when you have a lower level of income.
Low mortgage payments at the beginning of your mortgage repayment schedule – can be beneficial, especially if you want to increase your savings. Another benefit from the lower monthly payment is that you can better plan your budget and be more relaxed because it will be easier to pay the monthly obligation.
Higher buying power – because the initial monthly payment is lower. This means that you will have an opportunity to buy the home of your dreams. Even when this home might be more expensive, don’t forget that you have higher buying power.
GPM may be beneficial for borrowers with low credit scores – when low credit score borrowers cannot qualify for a conventional mortgage.
Disadvantages of graduated-payment mortgage
The ability to meet higher monthly payments – is considered to be a disadvantage because of the insecurity in your future payment ability. Namely, if your income doesn’t increase as expected, you might face a monthly payment too big for your budget. This can be considered as a potential disadvantage in terms of the uncertainty related to income increase. If you failed to anticipate a correctly potential increase in your income, then you may find yourself in a situation in which you don’t have a sufficient budget to cover the increased payments.
Higher overall cost compared to some conventional mortgages – is yet another drawback of graduated-payment mortgage. Let’s not forget the negative amortization feature as well.
Failure to understand how much the monthly payment will increase over time – can harm your financial health. Sometimes borrowers are not interested in fully understanding the size of the monthly period when the low introductory rate period is over. This, in turn, can result in an inability to meet your monthly payment and the beginning of potential financial problems.
When is it smart to take out a graduated-payment mortgage
This type of mortgage is not adequate for every borrower. Before rushing into the procedure to apply for a graduated-payment mortgage, you should prepare yourself. Meaning that you should check if you qualify for some of the other types of mortgage loans available. Next, consider the total cost of each mortgage you can qualify for and compare the overall cost. See if you need or want to buy the home now, or you can wait for a couple of years. This doesn’t mean that you should wait, but if the mortgage cost is too high because of low credit score, low income, etc., maybe it would be wiser to wait for a couple of years before purchasing a home.
You should also consider the stability of your job and the potential for an increase in your income level.
Graduate payment loan example
After going through the basics of GPM mortgage, it would be interesting to see how this loan works. Namely, table 1 I showing a calculation for a 30-year graduated-payment mortgage of $200,000. The interest rate is 6.5%, with a low introductory rate period of five years. The rate at which monthly payment increases is 7.5%. Go through the table? What can you notice? Look at the monthly payments each year?
Table 1: Graduate payment mortgage example
| Loan Amount | $200,000.00 |
| Interest Rate | 6.5% |
| Loan Term (in Years) | 30 |
| Initial Payment Amount | $940.84 |
| Number of Years of Increasing Payments Before Payment Levels Off | 5 |
| Percentage Rate at Which Payment Increases | 7.50% |
| Year | Year 1 | Year 2 | Year 3 | Year 4 | Year 5 | Year 6 – end of the mortgage term |
| Monthly payment | $940.84 | $1,011.40 | $1,087.26 | $1,168.80 | $1,256.46 | $1,350.69 |
From the table, you can see the difference between the initial monthly payment and the monthly payment after the introductory period is over. Namely, at the beginning, the initial monthly payment is slightly above $940. After the introductory period is over, your monthly payment will be fixed at nearly $1,350. The nearly $400 difference is more than obvious.
A graduated payment mortgage can offer numerous advantages for a home buyer, but it can also cause some potential problems. If you are certain about the income level increase, it would be good to buy a home with GPM. On the other hand, if you don’t have a stable job or income level, GPM can lead to financial problems. Hence, you should always inform yourself about the available options for your situation. Don’t rush into applying for the first mortgage you see. Always check your options.
