A graduated payment mortgage allows you to make lower monthly payments at the beginning of a loan and gradually increase those payment later in the loan. The graduated payment model was first used as student loans as a way to ensure recent graduates could afford payments. When applied to mortgages, the principal is the same, but the stakes are a little higher. Defaulting on a mortgage loan comes with much greater consequence than defaulting on a student debt. As a result, Graduate Payment Loans should be approached with caution.
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Affordability to First-Time Buyers
One of the target demographics for this loan is a young, or first-time home buyers. A first-time buyer has two challenges that lend toward the GPM loan: high initial cost to purchase the home and low income. A first-time buyer must come up with a down payment, furnish a home and incur other expenses that a repeat buyer will not face. As a result, the first-time buyer may have limited income in the early years of their mortgage. Further, first time buyers tend to be younger than most seasoned home owners and their income generally increases over time.
Extra Cash during Expensive Years
Another key individual who may benefit from a GPM loan is someone with a very expensive time in his or her life. For example, a family with children who are approaching college age may consider lowering the cost of their mortgage payments for a few years. Making lower in the initial phase of the loan and then slowly increasing those payments as the children move out of the home and into their own careers. If you know you will need all the cash you can get over the next three to five year period, a GPM can be a good option.
Default Risk in the Future
The main problem with a GPM is it provides for a reduced cost to day at the expense of a much higher cost in the future. With a traditional mortgage, you will have the same monthly payment throughout the life of the loan. In times when money is tight, you may be scraping by. On the opposite end, at times when you have extra cash, you are making the same monthly payment, so you can put funds away for saving or take on more luxury expenses. With a GPM, you do not have this flexibility. You agree to pay a little bit today and a lot in the future, regardless of what happens in the future.
Poor Planning Problems
Default risk is exacerbated with poor planning. With a GPM, you are exposed to a high amount of risk if you do not increase your spendable income as you originally planned at the beginning of your loan. If this occurs, you can still save the loan as long as you have saved accordingly. You should save at least three months income into a liquid account to be used at any point. This way, if you begin to see you cannot make payments, you will have enough money to buy some time to increase your income, sell the home, or refinance the loan.