Is a Graduated Payment Mortgage Right for You?

You’d like to buy a home but want to be responsible with your budget and not put too much strain on yourself. After all, you can’t plan for the future with precision, there will be contingencies and unexpected, unplanned events which will occur. Your income might change, you could be a position where relocation is a must, or have a great opportunity you just can’t pass-up.

At this point in time, you plan to stay in the same location for many years, but you just want to be as financially responsible as you can and you don’t feel comfortable with a 10 year or 15 loan and definitely don’t want to go the jumbo loan route. Since you’ll earn more in the next several years, someone recommends you look into getting a graduated home loan.

That certainly sounds like the perfect fit, but you’re unsure because you’re not really sure what it is exactly and want to go into the home buying process with as much information as possible. That makes a lot of money sense and now that you’re contemplating about getting such a mortgage, you’d like to know the ins and outs.

The Basics of a Graduated Mortgage Payment

Essentially, the namesake is a good explanation of what a graduated mortgage payment is and how it works. It’s ideal for those soon-to-be home buyers who are just starting in the careers or even people that want to begin with a lower monthly obligation. Of course, the payments gradually increase over time and then, eventually, become a fixed amount. This happens slowly so the borrower has sufficient time to make the necessary financial moves to afford the increased payments.

Graduated Payment Mortgages are FHA loans for home buyers who currently have low to moderate incomes but expect them to increase substantially over the next 5 to 10 years. Through this FHA loan program, also referred to as Section 245, those who have limited incomes are able to purchase a home and make mortgage payments that will grow along with their earning potential. —Federal Housing Administration

Generally, the payment begins quite low and then goes up by a certain percentage each year until it reaches a fixed sum. These kinds of home loans are available to homebuyers in 15 year and 30 year terms, and is offered by all FHA lenders. As an example, let’s say you take-out a 30 year mortgage loan. With a traditional, conventional loan, you pay a fixed amount, which includes principal and interest. With a GMP, your payments does not cover interest. Instead, you pay, for instance, 5 percent more each year. This is called “negative amortization” and it does mean you’ll pay a bit more for this kind of home loan.

GMP Pros and Cons

Just like with any other financial commitment, there are pros and cons. For example, an adjustable rate mortgage and an automatic rate reduction both lower you monthly payment when interest rates drop. However, it’s not necessarily “automatic”, in many instances, you’ll have to apply or request the rate be lowered.

Here are the pros and cons of a graduated mortgage payment:

Pros:

  • Allows young families or those who want a lower payment, to buy a home without a large monthly commitment.
  • The lower monthly payment allows the borrower to save money and adjust their finances to prepare for the next year, when the payment goes up.
  • A good match for borrowers who will make more money as their career advances or small business entrepreneurs who will make more money as their company grows.
  • Is available in 15 year terms and 30 year terms, just like a traditional, conventional loan.

Cons:

  • The borrower’s payment will go up each year and that means having to earn more and/or adjust their monthly budget to meet the increasing obligation.
  • Borrowers will have to accurately assess how much they will earn as the years go by, as well as plan for emergency situations that take-away from discretionary spending.
  • A graduated mortgage loan is generally more expensive than a 15 year conventional, a 30 year conventional; and, even an adjustable rate mortgage over time.
  • If a borrower does not accurately plan or is blindsided by an unforeseen, costly situation, that might cause financial trouble.
  • A change in the borrower’s career, like changing jobs or relocating, can have a negative impact.

The bottom line is, for a GMP to be right for you, you must be in the right situation and stay there for it to work for you. This is a great loan product, but like all debt instruments, it necessarily means you’re taking a bit more than a calculated risk. Speak with a mortgage specialist and/or a financial adviser about getting this type of loan and if it’s the best one or if you ought to take out a different kind of home loan.