A graduated payment mortgage, or GPM, is a mortgage with a fixed interest rate that starts with a low monthly payment that increases with time until it eventually levels off and remains fixed through the remainder of the mortgage term. At the end of a typical GPM mortgage term the loan is fully paid off. The purpose of a GPM is to provide a low initial monthly payment to allow a borrower to qualify for a loan who would not normally qualify for a fixed rate mortgage of the same amount.
A "typical" graduate payment mortgage will have a payment that increases annually by 7.5% to 12.5% of the previous year's payment for the first five years of the loan. After that the loan payment remains fixed for the remainder of the loan. Other rates of increase and graduated payment periods do exist. Graduated payments over five and ten years are common.
It is important that borrowers considering a graduated payment mortgage have good prospects for increasing income over time to enable them to pay the increased payments as the mortgage payments grow through the early life of the graduated payment mortgage.
Conforming and Nonconforming Graduated Payment Mortgages
As is true of other mortgage types, graduated payment mortgages may either be conforming or jumbo (nonconforming). A conforming graduated payment mortgage is a GPM whose loan amount is below loan limits set by the Federal National Mortgage Association (FNMA or Fannie Mae) and the Federal Home Loan Mortgage Corporation (FHLMC or Freddie Mac). In 2006, these limits are:
Note: These limits are fifty percent higher for one to four family mortgages in Alaska, Hawaii, Guam, and the U.S. Virgin Islands.
A jumbo or nonconforming graduated payment mortgage is an GPM that is over these limits.
Graduated Payment Mortgage Term
Graduated payment mortgages are available with 15 and 30 year terms, similar to other types of mortgages..
Graduated Payment Mortgages and Negative Amortization
Negative amortization exists when a mortgage's monthly payment is not sufficient to cover the interest due on the mortgage. In a negative amortization situation, the unpaid interest actually gets added to the amount of the mortgage causing the mortgage balance to rise. Partial amortization is also possible when the monthly payment is enough to cover the interest payment but does not cover all of the principal payment owed.
Negative amortization occurs during the early years of a graduated payment mortgage. During these early years the actual amount owed by the borrower increases. By the time the GPM mortgage payment levels off negative amortization ceases and a GPM amortizes over the remaining period of the loan so that the loan is completely paid off at term.
Graduated Payment Mortgage Terms and Conditions
It is important for borrowers to understand some of the more common terms and conditions for graduated payment mortgages, and all mortgages for that matter. Mortgages have a "due on sale" clause. This clause means that the mortgage must be paid off if the borrower sells their home. In addition, some mortgages may also have a "demand clause". A demand clause allows a lender to demand full repayment of a mortgage for any reason.
Some GPMs may also have a prepayment penalty. A prepayment penalty is a cash penalty that the borrower pays if they payoff their mortgage before the loan is due. Prepayment penalties can be referred to as "hard", meaning that the prepayment penalty will be levied if the loan is paid off early for any reason including the sale of the borrower's house. GPMs may also have "soft" prepayment penalties. In a soft prepayment penalty the penalty only applies to mortgages paid off by refinancing. Typically, prepayment penalties decline over a period of time and usually no longer apply after a mortgage is 5 years old. Many prepayment penalties will allow the borrower to make partial prepayments of their mortgage.