A graduated payment mortgage is a type of FHA home loan that can help homebuyers who currently have moderate incomes, but anticipate their income to increase over the next 5-10 years. These mortgages start with a lower monthly payment in the beginning, which rises over the first few years until it levels off for the remainder of the term.
FHA Graduated Payment Mortgages
All FHA lenders can offer FHA Graduated Payment Mortgages, which begin with a lower monthly payment that increases annually over the first 5-10 years of the loan, and then it levels out to a fixed monthly payment for the remaining years of the mortgage.
There are five FHA Graduated Payment Mortgages offered in 15-year and 30-year terms. The difference between the plans lies in the rate of increase of the mortgage payment, which annually increases 2.5%, 5%, or 7.5% until it levels off.
Here is an example of a Graduated Payment Mortgage:
…let’s say you have a 30-year mortgage in which the monthly payments increase by 5% each year for the first ten years. After those ten years, the rate will have leveled out and will no longer increase. You now have to pay this new, higher monthly rate for the rest of the loan—in this case, 20 years.
The downside to a Graduated Payment Mortgage is negative amortization.
Since the initial mortgage payments of a Graduated Payment Mortgage aren’t sufficient to cover the interest portion of the mortgage payment, the unpaid interest is added to the loan balance, resulting in negative amortization.
It’s important to remember that since the unpaid interest is added to the loan balance, the borrower not only pays interest on the principal borrowed to purchase the home but also on the unpaid interest.
And remember that as a result of having lower mortgage payments at the beginning of the loan, the later monthly payments will be higher when compared to a conventional mortgage.
We specialize in conventional home mortgages, FHA, VA, and USDA mortgage options, refinance loans, and reverse mortgages. We’ve worked extensively with cash-out refinancing, and help clients to lower their monthly mortgage payments.