Graduated Payment Mortgage (GPM)

A Graduated Payment Mortgage is simply a mortgage that starts out with lower payments that rise over time. GPMs are useful for buyers who need lower payments to qualify for a loan they might not otherwise be approved for with a regular fixed rate mortgage. Just like a normal fixed rate mortgage, the interest rate remains constant throughout the life of the loan.

The difference is the payment rises by a fixed amount, expressed as a percentage rate, over a specified period of time. For example, you might have payments that start low and rise by seven percent over a five year period. The tradeoff on a GPM is a smaller payment now for a larger payment later on. The monthly payments at the end of the graduated period will be higher than they would have been for a standard fixed rate mortgage.

At the very beginning of a GPM, the monthly payments are not enough to cover the interest of the loan. This leads to negative amortization, where the unpaid interest is added back to the principle of the loan. This effect does not play a big part in GPMs, but does contribute to the higher payments after the graduated period has ended.

GPMs are certainly not the only type of loans that feature rising payments in the future in exchange for lower initial payments. The interest-only loans discussed elsewhere on this site also feature a variation of this theme. However, interest-only loans feature payments that stay constant longer, and do not result in negative amortization. However, while their later payments do not increase as much, the initial payments are not as low as with a GPM.

There are several adjustable rate mortgages (ARMs) that also feature lower payments early on in exchange for higher payments later, most notably flexible payment ARMs. The primary advantage GPMs possess over these loans is certainty. A GPM borrower has to deal with rising payments, but knows exactly how much payments will rise in advance. A flexible payment ARM borrower is taking a gamble, and can’t be sure how much his payments will increase over time.