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By: Edward McCarthy
President: Sell By Owner Listings, Inc.
Graduated Payment Mortgage
Most borrowers are aware of fixed rate and
adjustable rate mortgages, but not many have heard of graduated payment
mortgage. This kind of mortgage presents another alternative for
borrowers looking for a mortgage loan product to fit their needs. With
a graduated payment mortgage, the payments start out being low and rise
over time. When the loan officer qualifies the borrower for a graduated
payment mortgage, the initial (low) payment is used. This usually
allows the borrower to qualify when he might not qualify for a
fixed-rate mortgage.
How it Works
Similar to a fixed-rate mortgage, the
graduated payment mortgage has a fixed interest rate for the life of
the loan. The payments on the graduated payment mortgage start out at a
certain level and increase periodically by a percentage for a specific
period of time. For example, monthly payments on a $100,000 graduated
payment mortgage might start out at $900 and increase by 7% every year
for 5 years. After five years, the graduation is complete and the
payments are fixed for the remainder of the loan.
During the graduation period, the graduated
payment mortgage the monthly payments are not high enough to cover the
interest on the mortgage. This causes a negative amortization. At the
end of each year, the unpaid interest is added back to the loan causing
the balance of the loan to increase. The good news is that at the end
of the graduation period, your payments begin to cover both the
principle and the loan, thereby decreasing your balance.
GRM vs. ARM
Graduated payment mortgages are often
compared to adjustable rate mortgages because of the variation in
payments over time. However, these two loan products differ greatly in
many aspects. For one, the graduated payment mortgage has a fixed
interest rate meaning the interest rate does not change for the life of
the loan. With an adjustable rate mortgage, however, the interest rate
does change.
The scheduled payments for a graduated
payment mortgage are calculated in advance. On the other hand, payments
for an adjustable rate mortgage can vary from one time period to the
next depending on the terms of the loan.
Who might benefit
First-time homebuyers who are just starting
out in their careers are ideal candidates for graduated payment
mortgages. Since first-time homebuyers typically do not have high
incomes, a graduated payment mortgage option makes it easier to qualify
for a home loan. In addition, those who are new in their careers
typically expect to have pay increases over time, which allow them to
predict the ability to make the graduated payments.
Potential Risks
A borrower with a graduated payment mortgage
runs the risk of overestimating their future earning potential making
it difficult to afford the mortgage in the future. If the homeowner
sells the home before the loan begins to amortize, he runs the risks of
losing money on the home, especially if it devalues during that period
of time.
As with any other loan product, a borrower
should assess both the benefits and the risks of a graduated payment
mortgage before making a decision.
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