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"I was told that the only way I could qualify
for the loan I wanted was with a GPM. What is that?"
GPM stands for "graduated payment mortgage",
meaning a mortgage on which the payment starts low and rises over time. Since
the initial payment is used to qualify the borrower, the GPM may allow a
borrower to qualify who would not qualify with a standard fixed-rate mortgage (FRM).
For example, the mortgage payment on a
$200,000 FRM for 30 years at 6% is $1199. Stretched over 40 years, the payment
would be $1100. But the initial payment on a 30-year GPM at 6.50%, on which the
payment rises by 7.5% a year for 5 years, is only $941. The interest rate on the
GPM is fixed, just as it is on a standard FRM.
The quid pro quo for the low initial payment
is a larger payment later on. The payment on the GPM rises for 5 consecutive
years, reaching $1351 in month 61, where it stays for the remainder of the term.
The initial payment on a GPM does not cover
the interest. The difference, termed "negative amortization", is added to the
loan balance. In the example, the loan balance peaks at $202,905 in month 36
before it starts down. Not until month 61 does the balance fall below $200,000.
This rising balance is a feature that lenders don�t like, and it is why they
charge a higher rate for GPMs than for FRMs.
Other GPMs have different rates of payment
increase over different periods. One has a 3% graduation rate over 10 years
instead of 7.5% for 5 years. Assuming the same 6.5% rate, the initial payment
would be higher at $1031, rising to $1388 in month 121. Negative amortization,
however, is smaller, peaking at $200,908 in month 24.
The GPM is not the only type of mortgage with
rising payments. FRMs with temporary buydowns also carry lower payments in the
early years. For example, the payments in the first two years on an FRM with a
2-1 buydown are calculated at rates that are 2% and 1% lower than the rate on
the FRM. On a 6% 30-year FRM of $200,000, the first year payment would be $955,
rising to $1074 in year 2 and to $1199 in years 3-30. And the buydown loan
amortizes as it would without the buydown � there is no negative amortization!
For a temporary buydown to work, however,
someone must fund the required buydown account. Withdrawals from this account
supplement the payments made by the borrower in years 1 and 2 so that the lender
receives the same payment ($1199) throughout. The $4436 required for the buydown
account must be provided either by the borrower or the home seller. GPMs don�t
require a buydown account.
Rising payments are also available on many
types of adjustable rate mortgages (ARMs), most notably on the flexible payment
or option ARM that I have written about in the past. Under its minimum payment
option, the first-year payment on this ARM is calculated at rates as low as
1.95%. On a $200,000 30-year loan, this amounts to $734, strikingly lower than
the $941 on the 5-year GPM.
Increases in the ARM payment, furthermore,
are limited to 7.5% a year for the first 5 years, just like on the 5-year GPM.
In year 5, therefore, the ARM payment has risen to $980 as compared to $1256 on
the GPM.
In month 61, however, the chickens come home
to roost. The GPM payment rises by 7.5% one more time, to $1351, where it stays.
The ARM payment increase, on the other hand, could be 7.5%, or it could be 75%
or even higher, there is just no way to know. As can be seen from the tables in
Flexible Payment ARMs, the
range of possible outcomes is very high.
The core difference between the GPM and the
flexible payment ARM is that the borrower with a GPM knows in advance exactly
how and when the payment will change. The ARM borrower, in contrast, is throwing
the dice. A new eruption of inflation is bound to cause market rates to rise
markedly, which will clobber all ARM borrowers, but especially those who
selected the minimum payment option on a flexible payment ARM.
GPMs carry risk to borrowers, who must be
able to meet the scheduled rise in payments, but the risk is known and at least
partly within their control. The one broad economic event that would hurt them
is severe deflation, which at this juncture is extremely unlikely.
Copyright Jack Guttentag 2004
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