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What Is a Graduated Payment Mortgage?

Last updated 04/30/2024 by

Ossiana Tepfenhart
A graduated payment mortgage loan is a fixed-rate FHA loan that has payments that increase gradually. These are excellent for people who may need to get a better job to make homeownership affordable. GPMs will increase every year until they reach their maximum monthly payment.
Getting a home often means that you will need to have a loan to fund it. These are called mortgages, and when you first go shopping for a house, it can be overwhelming to see how many different types of mortgages lenders have been able to come up with.
Graduated payment mortgages are a mortgage type you may not have heard of that is increasing in popularity, and it’s easy to see why. This mortgage allows you to pay less in the early years and still save money in interest when compared to a regular fixed-rate mortgage. So, what is a graduated-payment mortgage?
A graduated payment mortgage is a specialty FHA loan that lets your monthly mortgage payments start low, but increase year after year. It’s a special solution for people who want to get a home but know they will be able to afford it later on.

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Graduated payment mortgages Vs. Fixed and variable mortgages

Before we get into graduated payment mortgages, let’s talk about the two big categories. Mortgages are classified into fixed-rate and adjustable-rate (also known as variable rate) mortgages. Variable-rate mortgages will have their monthly payments go up and down with the market’s current status. Fixed rate mortgages do not have changing interest rates.
Technically, a graduated-payment mortgage is a fixed interest rate mortgage. Graduated payment mortgages (GPM’s) fall under the fixed-rate category. It is a type of mortgage in which the payments made monthly start small and increase gradually over time.

Why are graduated payment mortgages fixed-rate if the payments change?

With a GPM, the payments are what change. The interest rate charged, though, remains stable throughout the term of the loan. As a result, it’s still a fixed interest rate loan. It’s just not a fixed payment loan.

Who should get a graduated-payment mortgage?

Graduated payment mortgages work favorably if your current income isn’t a great deal, but is expected to get better over time. For example, if a person starts a new job as a major manager in a company and decided to buy a home, they may get a graduated-payment mortgage because the monthly bills might be too much for them right now.
Though the regular bills would be too much now, they won’t be in a year. Since that person has a reason to feel that way, it makes sense that they plan ahead in that manner.

How do graduated-payment mortgages work?

Graduated mortgages are meant to be easy for people who are just starting to get situated in life. They are mostly made for low-income earners and people who want to start small. If you sign up for a GPM, you should expect the following:
  • Your interest rate will not change, but your monthly payments will increase year after year. The payment increase falls between 2 – 12% each year until a maximum payment amount is reached.
  • You will be able to know exactly how much you owe every month. Part of the benefit of having a graduated payment loan is that you never have to worry about any guesswork. Every single payment is scheduled out and calculated out ahead of time.
  • You may not have to worry about a large down payment. The down payment for GPM loans can be as little as 3.5% of the total mortgage fee. However, you might get better terms with a larger down payment.
  • Your loan will be part of the FHA loan program. GPM’s are exclusively available in the United States to individuals who have their mortgages insured by the Federal Housing Administration (FHA). GPM’s are referred to as Section 245 of The Federal house administration.

How long does your initial payment period last?

This all depends on the specific loan that you take. The initial payment period is the first set of years where the payments continue to increase year after year. Once you hit the maximum payment amount, your monthly bills stay steady.
Most graduated payment loans will have an initial payment period of five or 10 years. You can expect your loan payments to increase by 2, 5, or even 7.5 percent over the course of the loan’s initial period.

How to Calculate Graduated Payment Mortgage Payments

Your graduated payments will depend on the loan amount, interest rate, and by how much you agree to increase your payment every year (or whatever time period you choose). Honestly, most people will want ot leave this to a GPM calculator or call their mortgage lender. The exact function or formula used by lenders may vary, but here’s a brief explanation on how to calculate it yourself.
The equation for the first year of a graduated-payment mortgage is
graduated mortgage payment
In the formula, L stands for the loan term in years, N is the number of graduations in GPM, i is the annual interest rate expressed as a decimal, and g is the graduated growth rate as a decimal.
Once you calculate the first year’s payment, you can calculate the second year by multiplying the first year payment by a factor of (1 + g) where g is the graduated growth rate as a decimal. Do the same — multiply previous payment by (1+g) — for every year you need to calculate payments.
Here’s an example of the graduated payments you would expect to have if you got a $200,000 mortgage with a 10-year term, a 4% interest rate, and a 5% graduated growth rate.
YearMonthly Payment
Total paid$245,228.42
If you are ever worried that the mortgage payments might increase too fast for your salary, it may be best to ask your mortgage lender for a quick run-through of your monthly mortgage payments on a proposed loan before you sign up.

How does a graduated-payment mortgage cause negative amortization?

Negative amortization is a term that means you’re paying less than the standard interest amount for a specific period. When this happens, the principle interest gets added onto the loan balance. This can actually make your loan balance grow instead of shrink, even if you are paying your bills on time.
There are several issues that can occur. The most important is that you may owe more than you the home is worth. This may cause problems when it comes to selling the home and can also put you at risk of foreclosure.

Do all graduated payment mortgages have negative amortization?

Nope. In fact, this is actually a pretty rare occurrence. Most lenders try to avoid giving anyone a negative amortization loan. If you are a homeowner owing minimum payments, this might be a risk. However, it’s not always easy to predict which people will end up in a negative amortization loan.

How can you prevent negative amortization?

This is actually pretty simple. The best way to prevent negative amortization is to beef up your credit score and find a mortgage that has a fairly low interest rate. GPMs that have a high interest rate are far more likely to have problems with negative amortization.
Of course, there is something to be said about avoiding it altogether. The best way to prevent a GPM from getting issues with negative amortization is to choose a more traditional mortgage instead.

Graduated Payment Mortgage Application Checklist

So, what do you need in order to get a GPM? It’s actually fairly simple. Like with all other loans, the exact requirements will vary from lender to lender. It’s important to ask each mortgage lender which standards they have.
  • A minimum FICO score of 620 is generally required.
  • Proof of income and identification.
  • A DTI ratio that is under 43 percent.
  • Mortgage insurance premiums will usually be required.
  • A 3.5% down payment minimum.
  • You can only purchase a single-unit, owner-occupied property with a GPM.

Graduated Payment Mortgages: Pros And Cons

Like with all types of loans, your graduated-payment mortgage has its perks and pitfalls. It’s best to know the positives and negatives of your mortgage—if you choose to get it.
Here is a list of the benefits and the drawbacks to consider.
  • The 3.5 percent down payment minimum is very affordable. In some cases, you might also get down payment assistance since it’s an FHA loan program.
  • It makes life much easier for low-income earners who hope to become mid-tier.
  • You get easier budgeting for the first years of your mortgage.
  • You get to become a homeowner quicker than other conventional mortgage payments would permit you to be.
  • If you fail to get a higher wage, you may fall behind on your payments.
  • In some cases, your interest rates may be so high that it doesn’t actually make a dent in the principal borrowed.
  • GPM’s may come with prepayment penalties attached.
  • If you end up with a negative amortization loan, you won’t be able to sell your home because the proceeds won’t cover the sale in many cases.
  • Another major disadvantage associated with a graduated-payment mortgage is that there is a higher chance of foreclosure. Wages aren’t always guaranteed, you know.

Adjustable-Rate Mortgage vs. Graduated Payment Mortgage

Adjustable-rate mortgages (ARM) and graduated payment mortgages (GPM) might seem similar. They both have monthly payments that can change over the duration of the loan. However, they are completely different.

How does an ARM change its payments?

An adjustable-rate mortgage fluctuates from time to time to reflect the market interest rate. A certain interest rate is fixed for a starting period that falls between three to ten years. When the period of this fixed interest rate is over, the incoming interest rate can move up or down based on an index.
Unlike the graduated payment mortgage, the ARM interest rate changes periodically without prior notice, and it is not based on a fixed schedule. So basically, the interest rates become unpredictable after the first few years; they increase or decrease, leaving the borrower uncertain of how high or low the incoming interest will be.
ARMs, in general, are a lot more unpredictable when compared to GPMs. Because you don’t know which way the market goes, you can’t figure out how much you will pay in 10 years from now.

How does a GPM change its payments?

On the other hand, the GPM is based on a loan repayment schedule, it changes, but unlike the ARM— it is predictable. GPMs come with a set schedule of monthly payment raises built into the loan. There are no surprises here. The only time this isn’t true is when deferred payments come into the picture.
Moreover, it’s important to note that graduated payment mortgages don’t actually vary their interest percentages. You’re actually just shuffling around the amount that you are paying month to month. Interest can still accrue over the course of your payment schedule, however the actual interest rate will stay steady.

Frequently asked questions about graduated payment mortgages

Who should consider getting a Graduated Payments Mortgage?

Graduated payment mortgages are ideal for people who currently earn a modest income but have good reason to believe that it will improve within the next couple of years.

How are graduated payments calculated?

The GPM can be calculated using the mortgage loan amount, the annual graduation rate, the interest rate, and the number of graduations you’ve applied for. Each lending company has a slightly different formula with different options.

Can the repayment schedule for a Graduated Payment mortgage fluctuate?

There is no way this could ever happen; whatever the fixed repayment schedule remains untampered with. The only cause of increment can be from deferred payments. In those cases, the amount defaulted will be added to the principal loan.

What are the major risks associated with graduated payments mortgages?

The major risk factor is whether the borrower’s income rises enough to handle the larger payments.

What’s the difference between a graduated-payment mortgage and a growing equity mortgage?

Growing equity mortgages and graduated payment mortgages are similar in the sense that payments increase over time. However, there is a big difference to consider. Graduated payments mortgages typically start with payments that are lower than the interest due on the mortgage, which leads to an initial negative amortization. Growing equity mortgages on the other hand start with a regular mortgage payment and increase by a fixed percentage.

Key takeaways

  • Graduated payment mortgages are fixed-rate mortgages that have monthly payments that increase as the mortgage ages.
  • GPMs are ideal for people who have a moderate income that will increase in the future.
  • With a GPM, your payment will increase, but not your interest rate.
  • Since graduated payment mortgages are FHA loans, you can get them with a low down payment.

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