Graduated Payment Mortgages

How Payments Step Up

With a GPM, your interest rate is typically fixed, but your payment isn't. Payments start low and rise by a set percentage each year for a set number of years, often 2% to 7.5% a year for five to ten years. After that, the payment levels off and stays the same for the rest of the loan.

The best-known version is the FHA Section 245 program, which offers several step-up plans. Because the schedule is written into your loan, you'll know every future payment the day you close. There are no surprises, just planned increases.

For example, a GPM might begin with a payment several hundred dollars less than a standard fixed-rate loan. Each year it increases a little, and by year six or so it's higher than the standard payment would have been. From then on it stays flat.

Because the payment increases are automatic, it's important to be honest with yourself about your future income. Ask whether a raise is likely, or simply hoped for. Your lender will also review whether you can handle the higher payments that come later, not just the starting payment.

Negative Amortization

Here's the most important thing to understand. In the early years, your lower payment may not even cover all the interest you owe. The unpaid interest gets added to your loan balance. This is called negative amortization.

That means your balance can actually grow for the first few years instead of shrinking. Eventually, as payments rise, you start paying it down. But you'll usually pay more interest over the life of the loan than you would with a standard fixed-rate mortgage.

Negative amortization also means you build equity more slowly. If home values stay flat or fall, you could owe more than the home is worth in the early years, which makes selling or refinancing harder.

Today's qualified mortgage rules restrict loans with negative amortization, which is one reason GPMs are rare. Where they are offered, usually through the FHA program, lenders must clearly show how your balance will change over time. Always ask for a year-by-year schedule so you can see exactly what you'll owe and when.

Who It Suits

A GPM can make sense for:

• Young professionals early in their careers, like new doctors, lawyers or engineers, who expect their income to rise steadily
• Buyers who need a lower payment now to qualify for the home they plan to stay in long term
• People with predictable raises, such as those on a set pay scale

It's usually not a good fit if your income is uncertain, you might move within a few years, or you want to build equity quickly.

Today there are other ways to lower an early payment, such as a temporary buydown or an adjustable-rate loan. As a Certified Mortgage Planning Specialist, I'll compare a GPM with those options and help you choose the approach that best matches where your career and finances are heading.

Whatever you choose, the goal is the same: a payment that fits your life today and still works five and ten years from now.