Graduated Payment Mortgages

Graduated payment mortgages are just what their name implies in that, with this type of mortgage, the monthly payments start out at their lowest level and increase at a specific rate, usually for not more than 15 years of the term of the mortgage. The payments then stay the same from that point on. Note that the interest rate isn't what is changing during the term of the loan. The interest rate is not adjustable for graduated payment mortgages. What is changing is the amount of the monthly mortgage payment.

Who's a good candidate for this type of mortgage when buying a home? Graduated payment mortgages are a good fit for those starting out on their career paths or anyone whose income is likely to go up in the near-future. Like two-step mortgages, graduated payment mortgages give you the opportunity to buy a home and make lower monthly payments at first, if that's all you can afford. Later in the loan term, your monthly payments go up when your income does too.

However, you will end up paying in dollars and cents for the opportunity to finance your home purchase with lower monthly payments each month. How so? Well, what's happening when you make those lower payments is that you're not keeping up with the interest that accrues on the mortgage each month. So each month that you make those lower payments, the interest you're not paying is added to the principal amount of your mortgage. The amount you owe on your mortgage, therefore, keeps getting larger because each month's interest is then figured out based on a bigger principal amount.

How about if you plan on staying in the home you're buying for only a few years? Well, you may be surprised to hear that this scenario doesn't necessarily mean this is the right type of mortgage for you and, in fact, it might be quite the opposite.

The graduated payment mortgage advantage. The advantage of graduated payment mortgages is the lower payments for the first years of the mortgage term. Each month that you make those lower payments, the interest you're not paying is added to the principal amount of your mortgage. Therefore, the amount you owe on your mortgage keeps getting larger because each month's interest is then figured out based on a bigger principal amount. So you see, if you were to sell your home during the first few years you owned it, the amount you would need to pay off your mortgage would be higher than it was when you first got your mortgage. In the worst-case scenario, if the housing market declines and your home hasn't appreciated or declines in value when you want to sell it, you may not get enough when you sell to pay off the mortgage you're now stuck with. Needless to say, this is not a situation you want to find yourself in!

Tip If you're considering a graduated payment mortgage because you can't afford the monthly payments on a conventional fixed rate mortgage or some other type of mortgage for the home you're buying, we urge you to rethink your purchase. Perhaps you could find a home that wouldn't be such a strain on your finances and avoid getting yourself into a situation that could potentially cause financial hardship to you and your family.