Graduated Payment Mortgage

Graduated payment mortgage definition

A graduated payment mortgage is a structured loan with smaller, more affordable payments at the beginning of the loan. The monthly payments gradually increase over time to make up the initial shortfall; graduated payment mortgage loans typically incorporate a fixed interest rate to allow predictable payment levels throughout the life of the loan. Mortgage eligibility is typically based on the initial required monthly payment; as a result, lower beginning monthly payments typically provide borrowers with additional purchasing power in the housing market.

FHA graduated payment mortgages

The most commonly available type of graduated payment mortgage is sponsored by the Federal Housing Administration (FHA). An FHA graduated payment mortgage is specifically designed for individuals and families with low to moderate income levels, but with significant potential for increased earnings within five to ten years. The mortgaged property must also serve as the borrower’s primary residence. Currently, there are five different types of FHA graduated payment mortgage arrangements; three offer gradual payment increases over the first five years of the loan, while the remaining two feature steady payment increases over the first ten years. Payments usually increase from between 2% to 7.5% over this period, depending on the length of time chosen and the starting point for the initial mortgage payment.

Advantages of graduated payment mortgage loans

Because the initial payments are typically much lower than those required by traditional mortgage loans, a graduated payment mortgage loan can allow borrowers to purchase a larger, more costly home than would otherwise be possible. Additionally, borrowers who remain in the home for a significant amount of time can accumulate equity in the home which can be extracted to handle emergencies and other cash flow difficulties.

Drawbacks of graduated payment mortgages

The low initial monthly payments for a graduated payment mortgage loan can create a false sense of security in some borrowers who may find themselves financially unprepared for the substantial increases that will occur as the loan matures. Additionally, because the initial payment amount typically does not cover the interest accrued on the loan, borrowers may experience negative amortization for an extended period of time during the early phases of the loan. This means, in simple terms, that the amount owed on the loan will increase steadily at the beginning of the loan term, and then begin to decline as the payments decrease. This can interfere with accumulating equity in the home during the early stages of the graduated payment mortgage and limit options for borrowers who may find themselves in unexpected financial difficulties.

For most borrowers, an FHA graduated payment mortgage or other graduated payment mortgage arrangement can provide a convenient entry point into the real estate market. However, borrowers should be mindful of the increased payments and the possible negative consequences to their credit history and their financial well-being if they cannot make the higher monthly payments when they come due.
Tim Ord
Ord Oracle

Tim Ord is a technical analyst and expert in the theories of chart analysis using price, volume, and a host of proprietary indicators as a guide...
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