Graduated-Payment Mortgage (GPM)

Definition

A Graduated-Payment Mortgage (GPM) is a type of home loan where the scheduled monthly payments start low and increase at a set rate over a predetermined period. Typically, this period lasts for the initial few years (commonly 5 to 10 years), after which the increments stop, and the payments level off for the remainder of the loan term. This type of mortgage is designed to provide an affordable entry-level payment structure for borrowers who expect their income to rise over time. The lower initial payments mean that the early payments may not fully cover the interest accruing, resulting in negative amortization and an initially increasing loan balance.

Examples

Young Professional Scenario:
- A young professional expecting significant annual raises opts for a GPM so their current lower salary can accommodate the initial lower mortgage payments. Over time, as their salary increases, they can comfortably manage the higher payments that occur later in the loan term.
Startup Owner Scenario:
- An entrepreneur starting a business anticipates that their initial income will be lower but expects substantial growth in their company’s revenue a few years down the line. They may choose a GPM to maintain affordable payments while their income is still growing.
Medical Resident Scenario:
- A medical resident with the expectation of a significant jump in income after completing residency might choose a GPM, as they will handle the readjustment in payments once they become a practicing physician.

Frequently Asked Questions (FAQ)

Who should consider a GPM?
- A GPM is suitable for individuals who currently have lower income but expect their financial situation to improve significantly in the future. These could include recent graduates, young professionals, or anyone expecting salary increases down the line.
What are the risks associated with a GPM?
- The primary risk is if the borrower’s income does not increase as expected, the higher payments in the later years could become unaffordable, potentially leading to financial stress or default.
How does the payment increase schedule work?
- The specific schedule and percentage increase in payments are defined in the loan terms. Typically, increases are made annually over the initial five to ten years of the mortgage, then the payments stabilize.
What is negative amortization?
- Negative amortization occurs when the monthly payments are not enough to cover the interest accruing on the loan balance, causing the outstanding balance to increase instead of decrease, especially during the initial phase when payments are lower.
Can I refinance a GPM?
- Yes, borrowers can refinance a GPM, just like any other mortgage, if they find it beneficial and meet the refinancing criteria set by the lender.
What credit score is needed for a GPM?
- While specific requirements vary by lender, a good to excellent credit score will typically be needed to qualify for a GPM due to the structured increase in payment amounts.

Amortization: Amortization refers to the process of gradually paying off a debt over a period through scheduled payments that cover both principal and interest.
Negative Amortization: This occurs when the scheduled monthly mortgage payments are insufficient to cover the interest accrued, causing the loan balance to increase.
Fixed-Rate Mortgage: A fixed-rate mortgage is a home loan with an interest rate that remains constant throughout the life of the loan.
Adjustable-Rate Mortgage (ARM): An adjustable-rate mortgage has an interest rate that can change periodically based on a corresponding financial index.
Loan to Value Ratio (LTV): The LTV ratio is a financial term used by lenders to represent the ratio of a loan to the value of an asset purchased.

Online Resources

References

“Graduated-Payment Mortgage (GPM) Definition,” Investopedia. Retrieved from Investopedia Website.
“Mortgage Payment Terms,” Consumer Financial Protection Bureau. Retrieved from CFPB Website.

Suggested Books for Further Studies

“The Mortgage Encyclopedia: The Authoritative Guide to Mortgage Programs, Practices, Prices and Pitfalls, Second Edition” by Jack Guttentag.
“All About Mortgages: Insider Tips to Finance, Buy, Build, Sit, Rent or Sell Your Home” by Julie Garton-Good.
“Mortgage Management For Dummies” by Eric Tyson and Robert S. Griswold.

Real Estate Basics: Graduated-Payment Mortgage (GPM) Fundamentals Quiz

### Who is a suitable candidate for a Graduated-Payment Mortgage? - [ ] Individuals with a fluctuating income - [ ] Retired individuals with a fixed income - [x] Young professionals expecting income growth - [ ] People who prefer low monthly mortgage payment throughout the loan > **Explanation:** Young professionals expecting income growth are suitable candidates for a GPM as their future higher income will help manage the initially low but steadily increasing payments. ### What financial condition does a GPM help compensate for? - [x] Initially low income that is expected to rise - [ ] Immediately high disposable income - [ ] Long-term stable income - [ ] Fixed pension income > **Explanation:** A GPM is helpful for borrowers with initially low income that is expected to increase, allowing them to afford the mortgage payments as their financial situation improves. ### What is negative amortization? - [ ] Payments that decrease annually - [ ] An outstanding balance that reduces over time - [x] An increasing loan balance due to insufficient initial payments - [ ] Interest rates that decrease over time > **Explanation:** Negative amortization occurs when the initial payments on a GPM are too low to cover interest costs, causing the unpaid interest to increase the loan balance. ### What phase do the lower payments in a GPM cover? - [ ] Final phase of the mortgage term - [x] Initial phase of the mortgage term - [ ] Middle phase of the mortgage term - [ ] The whole mortgage term > **Explanation:** The lower payments cover the initial phase of the mortgage term, typically the first 5-10 years, after which payments increase according to a schedule. ### How long do payments usually increase in a GPM? - [ ] Full term of the mortgage - [x] Predetermined initial years - [ ] Initially and then decrease - [ ] Final years of the mortgage > **Explanation:** In a GPM, payments usually increase over the predetermined initial years, commonly 5-10 years, before stabilizing. ### Which type of property buyers could particularly benefit from a GPM? - [ ] Buyers of rental properties - [x] First-time homebuyers with anticipated income growth - [ ] Senior citizens on a pension - [ ] Those looking to downsize their living space > **Explanation:** First-time homebuyers anticipating income growth would benefit from a GPM as it allows manageable payments in the initial years and higher payments when their financial situation improves. ### What feature differentiates a GPM from a fixed-rate mortgage? - [x] Payments increase over time in a GPM - [ ] Payments decrease over time in a GPM - [ ] Interest rate varies in a GPM - [ ] Payments remain the same in a GPM > **Explanation:** Payments increase over time in a GPM based on a predetermined schedule, whereas in a fixed-rate mortgage, payments remain the same throughout the loan term. ### What scenario might pose a risk for GPM borrowers? - [ ] Full repayment at the beginning - [ ] Stabilization of interest rates - [x] Income not increasing as expected - [ ] Decrease in property value > **Explanation:** A significant risk for GPM borrowers is their income not increasing as expected, leading to difficulty in affording the higher payments later in the loan term. ### What should borrowers expect during the initial phase of a GPM regarding their loan balance? - [ ] Loan balance remains constant - [ ] Loan balance decreases - [x] Loan balance might increase due to negative amortization - [ ] Loan balance is fully paid off > **Explanation:** During the initial phase of a GPM, the loan balance might increase due to negative amortization as the lower payments might not cover the full interest accrued. ### Why might a GPM be useful for entrepreneurs? - [ ] It has a high initial payment structure - [ ] Entrepreneurs avoid any form of loans - [x] It allows for lower initial payments as their business revenue grows - [ ] It is not suited for entrepreneurs > **Explanation:** A GPM is useful for entrepreneurs as it allows for lower initial payments while they focus on growing their business revenue. The incremental increases in payments align with expected future income growth.