Even if it’s not your first time buying a home, it may be hard to meet the income requirements to cover your mortgage payment. Lucky for you, you don’t necessarily have to commit to those big payments right away if you can get a graduated payment mortgage (GPM).
A GPM is a loan where payments initially start lower but gradually increase over time. By allowing borrowers with less cash flow to make smaller payments, GPMs help a variety of people get approved for a mortgage, especially first-time home buyers.
A GPM comes with its challenges, but it can be a good mortgage option if you’re having a hard time qualifying for conventional or Federal Housing Administration (FHA) loans.
Not sure if a GPM is right for you? Don’t worry, we’ve done most of the homework for you. Keep reading to find everything you need to know about GPMs.
Graduated Payment Mortgage, Defined
A GPM is a type of mortgage loan typically backed by the FHA. Its GMP loan program, also called Section 245, is intended for low-to-moderate income borrowers who expect their income to increase while they have mortgages.
GPMs plans can differ in term lengths, payment increase schedules and minimum down payment options.
How Graduated Payment Mortgages Work
So, how do GPMs work? The loan payment schedule starts with a minimum monthly payment that’s lower than the amount a borrower would pay if they had a fixed-rate mortgage of the same term length and at the same interest rate. Lenders structure GPMs this way to help prospective buyers qualify for a mortgage.
Payment amounts start low and gradually increase year after year for 5 – 10 years until they hit a maximum payment level. At that point, the borrower makes monthly payments at this maximum amount until the loan is fully paid off.
Lenders assume that the borrower’s income will grow during the 5 – 10 years so they can afford the graduated payments.
The annual increase typically follows one of two patterns[1]:
- A 5-year initial period of graduated payments increasing by a fixed percentage (2.5%, 5% or 7.5%) annually, becoming fixed in year 6
- A 10-year initial period with 2% or 3% annual increases, becoming fixed in year 11
The amount your payment increases depends on which year you are into the mortgage repayment.
Eligibility requirements
A GPM is only available to borrowers who are looking to buy a single-family home as a primary residence. GPMs are not available if you want to buy investment properties or vacation homes. Also, unlike some other FHA loans, the program is not available for buying 2- to 4-unit properties, even if you plan to occupy one or more of the units.[1]
You’re also subject to FHA loan limits, which means you can only borrow up to $420,860 – $970,800 depending on where you live.[2]
Like other FHA loans, you may be able to pay as little as 3.5% down with a credit score of 580 or higher.[3]
How Are Graduated Payments Calculated?
Like conventional mortgages, GPMs follow an amortization schedule.
Amortization is a process lenders use to determine how much interest you will need to repay over the life of your loan. They then use the amortization process to determine how much you’ll need to pay each month.
A fixed-rate mortgage is typically amortized so that you pay the same amount every month over the life of the mortgage. You’ll start out paying more in interest at the beginning, but over time more of your monthly mortgage payment goes to pay down your principal balance.
Graduated payment example
The math can get a little fuzzy when you’re adding to the payments each year, so we’ll break it down into a simple example.
Consider a $300,000 loan with a 30-year term at 3%. With a fixed-rate 30-year mortgage, you’d pay $1,264.81 every month ($15,177.72 each year) and you’d pay $155,332.36 in interest over the life of the mortgage.
With a GPM, you’d pay the same 3% interest rate, but with 5 years of graduated payments that increase by 5% each year. It would look like this:
| Year | Total Monthly Payment | Total Paid During Year |
| 1 | $1,023.84 | $12,286.08 |
| 2 | $1,075.03 | $12,900.36 |
| 3 | $1,128.78 | $13,545.36 |
| 4 | $1,185.22 | $14,222.64 |
| 5 | $1,244.48 | $14,933.76 |
| 6 – 30 | $1,306.71 | $15,680.52 |
During the first 5 years of the mortgage, you will have paid $7,999.80 less than you would have with a fixed-rate mortgage, but you’ll pay $502.80 more every year for the next 25 years for an additional $12,570.
At the end of the mortgage, you will have paid an additional $4,565.24 in interest compared to a fixed-rate mortgage.
Mortgage insurance premiums
Like other FHA loans, you will also have to pay mortgage insurance premiums.
This requires an upfront payment of 1.75% of the loan value ($1,750 per $100,000 borrowed) that can be added to your initial loan balance.[3]
You’ll then need to pay an annual premium that hovers around $42 per month per $100,000 borrowed for the first 5 years of the loan. After that, the monthly premium goes down incrementally over the life of the loan.[4]
If your lower initial payments aren’t big enough to pay for the interest accruing on your mortgage, the lender adds unpaid interest back into your loan, making your loan more expensive.
Pros and Cons of a Graduated Payment Mortgage
A graduated payment mortgage might be worth considering if you’re struggling to get approved for a conventional mortgage. However, there are a few other factors to note before you decide on this type of mortgage. Let’s take a look at a few of the pros and cons of GPMs.
Pros
GPMs are intended to benefit low-to-moderate income home buyers, especially those who are in a set career path or training program and expect income growth. We’ve listed a few advantages of these mortgages programs:
- Lower initial payments
- Approval for a home sooner in life
- More value or home from your property than you’d otherwise be able to afford
- Payments that grow with your income over time
- Predictable budgeting with fixed interest rates
Cons
For as many advantages as GPMs offer, they do come with a few drawbacks to be aware of as well. You could face any of these disadvantages or risks:
- Negative amortization that increases the loan balance and interest fees
- Later payments that are too high if your income doesn’t grow
- Higher overall costs if your down payment was small
- Possibility that a GPM may cost more than a conventional mortgage
- Penalties possible for early or overpayment
Graduated Payment Mortgage vs. Adjustable-Rate Mortgage
GPMs are loans with fixed-interest rates but with variable payments over time, which may sound a lot like an adjustable-rate mortgage (ARM). But GPMs and ARMs have some pretty fundamental differences.
With an ARM, you’ll start your mortgage with a low fixed-interest rate for a period ranging from 3 – 10 years. After that period ends, your lender can adjust your rate every 6 months, annually or every 2 – 5 years, according to market index rates and the terms of your loan.
Although ARMs usually come with caps and floors to limit the overall variability, it’s difficult to predict what your payments will look like down the line. With an ARM, you can buy a wider range of properties with fewer restrictions than a GPM.
Your payments with a GPM will start low and increase for the first few years until you hit the payment ceiling. After that, payments level out for the remainder of the loan term. With a GPM, your interest rate remains fixed, but the payments increase and then level off according to the percentage agreed upon in your mortgage.
Because your GPM payments are based on a set schedule of increases (instead of the market), it’s easier to calculate and predict how much you’ll pay later on.
A Loan That Graduates With Your Projected Income
If you’re having a hard time getting into the real estate market because of low income, not enough savings or other factors, a GPM can help you get started. Check with your lender to see if you qualify for a GPM, but don’t forget to consider all the pros and cons of a GPM versus other types of mortgages.
Regardless of your income, credit or financial status, it’s important to monitor your finances closely as you look into buying property. Leveraging good credit and other aspects of your finances can help you get the best rates and the right mortgage for your needs.