Because of the lower initial monthly payments, there may be negative amortization during the first year(s) of the loan. Negative amortization occurs when the scheduled payment does not cover the entire interest rate charge. The unpaid interest is added to the principal balance, creating negative amortization.
GPM loans are rarely available today, because their benefits and advantages do not really offset their costs and disadvantages. Again, most home buyers will discover that they are better off with a Temporary Buy-Down program or a standard 30-year fixed-rate loan, rather than the GPM.
Initially introduced by the Federal Housing Administration (FHA), the graduated payment mortgage (GPM) has lost much of its popularity. However, related programs have been developed to better apply the GPM’s basic objective.
The GPM was designed for borrowers and home buyers who anticipated future increases in their income. This program allowed such applicants to qualify for a larger mortgage loan and, thus, a bigger home purchase.
The most common program with a similar objective today is the Temporary Buy-Down program, which lowers the interest rates during the first one-to-three years of the loan. The applicant would then be qualified and underwritten based on the lower interest rate and monthly payment of the first year.
However, unlike the Buy-Down program, the GPM loan lowered the monthly payment but not the interest rate. Instead the GPM adjusts the monthly payments so that the borrower pays slightly less during the first years but slightly more in later years.
The biweekly plan is actually just another way of saving money by reducing the loan’s term. In addition to the
biweekly plan, consider these three additional options:
● Extra principal payments
● Refinance to a shorter term
● Graduated payment plan
Extra principal payment plan
As mentioned above, the extra principal payment program pays a little extra toward the principal balance of the loan, over and above the regular monthly requirements. By paying a little extra each month or once in a while, the borrower can dramatically lower the term of the loan.
For example, a 30-year $100,000 loan with an interest rate of 7.75% has a monthly payment of $716.41. If the borrowers were to make a monthly payment of $816.41 (an extra $100 toward principal), the loan would be paid off in about 24 years, for a total savings of about $50,000.
Refinance to a shorter term
If you can afford the commitment to a slightly higher monthly payment, refinance your 30-year mortgage into a 10-year, 15-year or 20-year mortgage loan.
The monthly payments will be higher because of the shorter amortization; however the interest rate is lower and the overall interest charges are dramatically less.
Graduated payment plan
Sometimes referred to as the graduated equity mortgage or growing equity mortgage, the graduated payment plan also shortens the loan’s term and reduces total interest cost. Although many variations exist, the basic pattern is to increase the payment amount at the beginning of each year. The extra payment earn interest income and is then applied toward repayment of the loan principal.
The biweekly program is not for all homeowners. In fact, there are disadvantages to this program. A question many financial analysts will point out is that why should you pay off future debt with current dollars.
Remember that every dollar you pay today will be worth about 50 cents (or less) in twenty years. With a typical 30-year loan, biweekly payments will trade each solid dollar today for 50 cents in the future. You are often better off using prepayment funds to pay off non-deductible, higher-rate debts—such as credit cards and personal loans.
The peace of mind of paying off your mortgage early and having fewer burdens in your later years is a big positive. But on a purely financial basis, the biweekly payment may not always be the best program for you. You have to calculate the potential savings–and non-monetary benefits–against the probable costs.