Benefits and Risks of a Graduated Payment Mortgage

For a potential homeowner, there are several mortgage options available, one of them being a graduated payment mortgage. With a graduated payment mortgage, the initial period of the loan has a low interest rate, and then over the next 3 to 5 years, the interest rate will increase and then stay fixed for the duration of the loan. This type of loan is on a negative amortization schedule. A negative amortization schedule is one for which you make a payment for less than the interest owed on the loan, creating deferred interest. The leftover interest is added to the principal. While it may not appear to be beneficial, depending on the circumstance, a graduated payment mortgage can work.

Benefits

There are several benefits associated with a graduated payment mortgage. First, it allows you to purchase a home without having a large income. A graduated payment mortgage can benefit a borrower who anticipates income growth within a few years of taking on a mortgage. Due to the low initial payments, people are able to make payments while increasing their earnings. Second, a graduated payment mortgage allows you to purchase a better home than if it were another type of mortgage. Graduated payment mortgages provide flexibility in the selection and cost of a home. Since the initial payments are low, it provides you some buying power. Overall, this type of mortgage relies more on your future earnings' potential than your current earnings as a means of being able to afford the home.

Risks

The risks associated with the graduated payment mortgage come from borrowers' not factoring in the increase in payments as well as their future earnings' potential. The payment increases are scheduled, but the amount of increase can be substantial. While the initial low payments are attractive, there can be a shocking wake-up call when the increases start to occur. If you are unaware of how much the increase will be, you may find yourself struggling to keep up with the payment amounts. Your future earnings potential plays a major role in graduated payment mortgages. If you miscalculate what your earnings' potential will be, you will put yourself in a situation to default on the mortgage and possibly lose your property.

Conclusion

Graduated payment mortgages can work to your benefit, but in order not to have trouble with this type of mortgage, do your research. Figure out what is a realistic earning potential for you in the future. You have to factor in any potential economic downturns, lifestyle changes or unexpected earnings. Talk to your lender about the structure of a graduated payment mortgage and what you can expect as increased amounts. This type of information will allow you to set up a budget to anticipate the increases. In addition, because you will have gradually increasing payments, keep the savings from the initial lower payments in a rainy-day fund. This should help provide cushion should your economic growth not occur as fast as anticipated. Remember that the initial savings are great, but you want to be able to keep your property in the long run.