What Is A Graduated Payment Mortgage (GPM)?
Scott Steinberg4-minute read
December 31, 2020
A graduated payment mortgage (GPM) is a form of home loan that is often favored by prospective home buyers with lower incomes, or who may lack significant savings with which to purchase a property. Under the terms of a GPM, initial mortgage payments start out small, then increase over time.
In effect, a GPM affords you the opportunity to purchase a piece of real estate now, although you may have less cash in hand. As a result, it’s often a popular choice with first-time home buyers, depending on their circumstances. GPM can come with drawbacks attached, though, so it’s important to do your homework before considering applying for one. Also note that Rocket Mortgage® does not currently offer this type of mortgage.
How Graduated Payment Mortgages Work
In essence, a graduated payment mortgage starts out by requiring a homeowner to make lower monthly minimum payments up-front. As time passes, the amount of these payments steadily increases. As with conventional home loans, a GPM comes with a fixed interest rate attached, although this interest rate is typically set at a lower number to help qualify buyers with lower incomes. Noting this, a graduated payment mortgage is often a more accessible choice for those whose incomes are also likely to gradually increase over time.
While a GPM’s monthly bills will start out smaller, payments inevitably grow as time passes, increasing annually by a set amount (e.g. by 5% – 10% each year) until a maximum payment amount is attained. At the time this maximum payment ceiling is reached, the maximum payment amount continues in effect until the mortgage is paid off. In other words, monthly GPM payments will increase each year for a preset period of time until the associated interest rate finally levels out to a fixed maximum monthly payment. Once reached, you will pay the higher monthly rate for the remainder of the loan’s lifetime.
Important to note as well: If you opt for a GPM, it may result in negative amortization. In other words, initial payment amounts may see you paying less out of pocket than the mortgage interest which is accruing on the loan. In effect, a negative amortization loan such as this can create interest charges which add to the total principal amount under the loan – causing the loan to be more expensive than a conventional mortgage in the end.
The majority of GPMs are backed by the Federal Housing Administration (FHA), and come in 15-year and 30-year varieties. In general, graduated payment mortgages are designed to be a suitable option for low-income borrowers who may otherwise lack the ability to make a sizable down payment.
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Graduated Payment Mortgages: Pros And Cons
As with any form of home mortgage or personal loan, GPMs come with pros and cons attached. You’ll wish to weigh both the upsides and downsides before deciding whether to proceed with an application.
Advantages Of A Graduated Payment Mortgage
- Greater ability to qualify for a home loan
- Opportunity to buy a home sooner
- Chance to purchase more home for your money
- Lower initial payments required
- Added flexibility with monthly expenses
- Evolves with your income over time
Disadvantages Of A Graduated Payment Mortgage
- Risk of financial trouble if income does not increase
- Higher overall costs (in similar fashion to PMI if less is paid up-front)
- Negative amortization may add to loan principal
- Requires you to accurately predict future income
- Total cost may exceed a conventional mortgage
- May come with prepayment penalties attached
Does A Graduated Payment Mortgage Differ From An Adjustable Rate Mortgage (ARM)?
A GPM essentially functions as a loan with a fixed rate and variable graduated payments. While both adjustable rate mortgage and graduated payment mortgage payments can change on occasion though, these types of home loans fundamentally differ in practice.
For example: Under the terms of an ARM, you can expect to be charged a fixed interest rate for an initial term period. At the time that this term period ends (ex: 5 – 10 years), the associated interest rate can grow or shrink based on market and index rates, causing your monthly payment to increase or decrease, respectively, by an uncertain amount.
By way of contrast, if you opt for a GPM, you can expect your monthly payment to change, but you’ll know well in advance of the time it shifts just how much this payment will change instead. Choosing a GPM can help you keep surprises to a minimum here. But don’t forget either: GPMs are uniquely built to cater to borrowers such as medical or dental students who expect to earn significantly higher incomes in later years. While designed to help borrowers who are having challenges meeting debt-to-income requirements today, a GPM isn’t necessarily as affordable overall as a conventional home mortgage. To this extent, applying for a GPM may result in you paying more than a conventional mortgage, and will require you to make a calculated bet on your future earnings and income.
GPMs can help you open more doors as a prospective home buyer. But like any other form of mortgage, they can also come with drawbacks attached. As a result, it’s a good idea to explore other financing options before committing to a graduated payment mortgage. First-time home buyers often have many opportunities available to them – as always, we recommend doing your homework before signing on the dotted line.
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