A Graduated Payment Mortgage (GPM) is a specialized mortgage plan designed to make homeownership more affordable to borrowers anticipating an increase in income. Under a GPM, the borrower initially makes lower monthly payments which gradually increase over time until they are sufficient to fully amortize the loan over its term. The incremental rise in payments typically allows borrowers to manage their financial budgets more effectively in the initial years following the purchase.
Structure and How It Works
Initial Period and Payment Increases
GPMs feature lower payments during the early years of the mortgage. This introductory period can vary but often lasts for the first five to ten years. During this time, the payments do not cover the interest accrued, resulting in negative amortization, where the loan balance increases.
Gradual Increases
Payments increase in steps annually according to a predetermined schedule until they level off. The increments are set in such a manner as to catch up with both the interest accrued and principal repayment.
Amortization Schedule
By the end of the graduated payment period, monthly payments will reach an amount sufficient to fully amortize the loan by the end of the term. The final payments will be higher than the initial payments but will stabilize once the scheduled increases are complete.
Historical Context
GPMs gained popularity through the Federal Housing Administration (FHA) under Section 245, which aims to facilitate homeownership for first-time borrowers, young buyers, and other individuals expecting future earnings growth. These mortgages became prominent in the 1970s and 1980s as a response to economic conditions requiring innovative lending solutions.
Applicability and Use Cases
Ideal Borrowers
GPMs are particularly beneficial for:
- Young professionals anticipating significant salary increases
- New graduates entering high-growth career fields
- Borrowers expecting a rise in household income
Types of Properties
GPMs are typically used for residential real estate, including single-family homes, condominiums, and townhouses.
Comparisons and Related Terms
Fixed-Rate Mortgage
Unlike GPMs, fixed-rate mortgages (FRMs) maintain consistent payments throughout the loan term. Fixed-rate mortgages offer payment stability but do not provide the initial affordability of GPMs.
Adjustable-Rate Mortgage (ARM)
ARMs feature fluctuating interest rates that adjust periodically. While ARMs can start with lower rates similar to GPMs, their rates and payments are not predictably graduated and depend on market indexes.
Negative Amortization
A key characteristic of GPMs, negative amortization occurs when the mortgage payments in the initial period are not enough to cover the interest, causing the outstanding loan balance to increase.
FAQs
What happens if my income does not increase as anticipated?
Can I refinance a GPM?
Are GPMs still popular today?
Summary
Graduated Payment Mortgages (GPMs) are a unique financial tool designed to assist borrowers in managing initial home costs with plans for future income growth. These mortgages provide lower initial payments that gradually increase, aligning with anticipated income rises. Primarily originated under FHA Section 245, GPMs cater to specific borrower groups, offering a pathway to homeownership that adapts to changing financial circumstances. Potential borrowers must weigh the benefits against the risks of negative amortization and the necessity for income increase to make informed mortgage choices.
