Most of the borrowers are aware of fixed rate mortgage and adjustable rate mortgage, but very few are aware of graduated payment mortgage. This type of mortgage provides another option for the borrowers, who are in search of a mortgage loan product that suit their requirements.
The monthly payment starts out being low and rises eventually with the graduated payment mortgage. The initial (low) payment is used when the loan officer qualifies the borrower for a graduated payment mortgage. This generally allows the borrower to qualify when he might not qualify for a fixed rate mortgage.
Working of Graduated Payment Mortgage
Just like the fixed rate mortgage, the graduated payment mortgage has a fixed interest rate through out the loan period. For the graduated payment mortgage, the payment begins at certain level and for a specific period of time it increase periodically by a percentage.
For instance, monthly payments might start out at $900 on a $100,000 graduated payment mortgage and for the next 5 years, it will increase by 7% every year. After five years, the graduation is complete and the payments are fixed for the remaining loan period.
The monthly payments on the graduated payment mortgage during the graduation period are not high enough to cover the interest on the mortgage. The unpaid interest is added back to the loan at the end of each year, which results in increase in the balance of the loan.
The good news with the graduated payment mortgage is that your payments begin to cover both the principle and the loan at the end of the graduation period, which results in decrease of your balance.
GRM vs. ARM
Most often, the graduated payment mortgages are compared to adjustable rate mortgages due to the variation in payments eventually. However, there many differences between these two loan products.
For example, the graduated payment mortgage has a fixed interest rate, which means that the interest rate is same through out the loan period. On the other hand, the interest rate changes with an adjustable rate mortgage.
The scheduled payments are calculated in advance for a graduated payment mortgage. Where as, for adjustable rate mortgage, payments can vary from one time period to the next depending on the terms of the loan.
Who Might Benefit
The ideal people for taking graduated payment mortgage are the first-time homebuyers who are just starting out in their careers. Since first-time homebuyers generally do not have high incomes, a graduated payment mortgage makes it easier for them to qualify for a home loan.
Additionally, those who are new in their careers generally expect to have pay increases in due course which allows them to predict the ability to make the graduated payments.
Risks with Graduated Payment Mortgage
The potential risk of obtaining graduated payment mortgage is that the borrowers are overestimating their future earning potential making it difficult to afford the future mortgage. If the homeowner sells the home before the loan begins to amortize, he runs the risks of losing money on the home, particularly if it devalues during that period of time.
Just like ant other loan product, a borrower should consider the benefits as well as the risks of a graduated payment mortgage before making a decision.
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