Graduated payment mortgages are useful options for those with low incomes, but whose incomes are expected to rise in the future. Graduate payment mortgages offer monthly payments and interest rates that are low at the outset, but then increase over time.
The increased payment aspect of graduate payment mortgages may make such mortgages sound like adjustable rate mortgages, but they're two different animals. With a graduated payment mortgage, the interest rates are set when you're accepted for the mortgage. You'll know exactly what rate you'll pay in the first year, second year, third, fourth and fifth years.
These mortgages offer you a low interest rate and monthly payment for the first year. In the second year of the mortgage, your interest rate is increased. The amount of the increase will vary with the lender, but usually ranges from 7.5% to 12.5% over the previous year's interest rate. So, for example, if your interest rate is 6% for the first year, and your mortgage calls for a 7.5% increase year over year, your interest rate for the second year will be 6.45% (6% multiplied by 7.5%, and added to the 6%). Your interest rate for the third year will be 6.93%. For the fourth year, your rate will be 7.45%. And for the fifth year, your interest rate will be 8%.
The interest rate after five years is then locked in, and that will be your rate for the balance of the mortgage. However, there are some graduated payment mortgage plans that extend the rising rate period out to ten years.
Graduated payment mortgages are generally only available for 15 or 30 year terms.
Because of the way that graduated payment mortgages are structured, the amount of principal owed on a home actually increases somewhat for the first three or so years. This is called "negative amortization." And this makes many lenders nervous, as a default on the mortgage will leave them with a mortgage balance that's greater than what they initially lent.
Fortunately, the Federal Housing Administration (FHA) has graduated payment mortgage plans that the agency insures, thus making lenders more agreeable to issuing such mortgages. More detailed information about the FHA programs can be found on their site at http://www.fha.com/graduated_payment.cfm
There are some serious points to consider before opting for a graduated payment mortgage. One is the negative amortization issue mentioned above: you're going to owe more on the home for the first three or so years than what you borrowed. Another consideration is that you'll pay more in interest over the term of the mortgage than you would with a conventional mortgage.
Another concern for the buyer is that, if he or she has to move during the negative amortization period, the amount owed on the mortgage could exceed the market value of the home.
For these reasons, pursuing a conventional mortgage may be more advantageous if at all possible.
An alternative to graduated payment mortgages is a mortagage buy down.
Another alternative is to choose a less expensive home for which you would qualify for a conventional mortgage.
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