What is a Graduated Payment Mortgage??
Graduated Payment Mortgage (GPM)
The GPM is another alternative to the conventional adjustable rate mortgage, and is making a comeback as borrowers and mortgage companies seek alternatives to assist in qualify for home financing
Unlike an ARM, GPMs have a fixed note rate and payment schedule. With a GPM the payments are usually fixed for one year at a time. Each year for five years the payments graduate at 7.5% - 12.5% of the previous years payment.
GPMs are available in 30 year and 15 year amortization, and for both conforming and jumbo loans. With the graduated payments and a fixed note rate, GPMs have scheduled negative amortization of approximately 10% - 12% of the loan amount depending on the note rate. The higher the note rate the larger degree of negative amortization. This compares to the possible negative amortization of a monthly adjusting ARM of 10% of the loan amount. Both loans give the consumer the ability to pay the additional principal and avoid the negative amortization. In contrast, the GPM has a fixed payment schedule so the additional principal payments reduce the term of the loan. The ARMs additional payments avoid the negative amortization and the payments decrease while the term of the loan remains constant.
The scheduled negative amortization on a GPM differs depending on the amortization schedule, the note rate and the payment increases of the loan. GPM loans with 7.5% annual payment increases offer the lowest qualifying rate but the largest amount of negative amortization.
On a loan of $150,000, with a 30 year amortization and a note rate of 10.50% with 12.5% annual payment increases, the negative amortization continues for 60 months. The qualifying rate is 5.75% and the negative amortization is 11.34% (approximately $17,010).
The note rate of a GPM is traditionally .5% to .75% higher than the note rate of a straight fixed rate mortgage. The higher note rate and scheduled negative amortization of the GPM makes the cost of the mortgage more expensive to the borrower in the long run. In addition, the borrowers monthly payment can increase by as much as 50% by the final payment adjustment.
The lower qualifying rate of the GPM can help borrowers maximize their purchasing power, and can be useful in a market with rapid appreciation. In markets where appreciation is moderate, and a borrower needs to move during the scheduled negative amortization period they could create an unpleasant situation.
Market Commentary
Friday: 03/07/08 10:30 AM EST: A weaker than expected jobs report and easing actions by the Federal Reserve gave Treasuries an initial boost this morning. But Treasuries have since fallen back and are currently only slightly ahead as the stock market is showing some resilience. The major indices are currently narrowly mixed. The employment news is exerting downward pressure while the Fed action is providing support.
The Labor Department reported this morning that the seasonally adjusted level of nonfarm payrolls fell last month by 63,000, the largest decline since March of 2003.
This was a much weaker reading than the 20,000 to 30,000 increase that analysts were forecasting. Moreover, January’s originally reported decline of 17,000 was revised to a drop of 22,000 and December’s previously reported increase of 82,000 was revised down to a gain of just 41,000.
In the goods producing sector, construction payrolls fell by 39,000 and manufacturing payrolls fell by 52,000. In the services sector, the largest gain came in the education and health category with a rise of 30,000. Leisure and hospitality payrolls rose by 21,000. But retail sales payrolls fell by 34,100, professional and business payrolls by 20,000, and financial services payrolls by 12,000. Government payrolls increased by 38,000.
Despite the declines, the unemployment rate (the portion of the active workforce without jobs) fell to 4.8% for the month, down from 4.9% in January and 5.0% in December. But the lower unemployment rate is being overlooked to some extent by traders this morning since it comes from a shrinking workforce. Today’s report said it declined by 450,000 last month.
The inflation indicator in today’s release was not too alarming. The report said that average hourly earnings rose in February by 0.3%. January’s originally reported rise of 0.2% was revised up to 0.3% but December’s previously reported increase of 0.4% was trimmed to 0.3%.
The other major news of the day concerns the Fed’s action to make more funds available to banks. One of the ways the Fed has done this is through direct loans. The interest rate charged for such loans is called the discount rate. Last August, the Fed’s monetary policy committee cut the discount rate by 0.50% from 6.25% to 5.75%. In addition, it extended the payback period. Additional cuts since then have reduced the rate to its current 3.50%.
But since borrowing directly from the Fed has been perceived as a sign of distress, many banks have been reluctant to use this source of funds. To address the situation, in December, the Fed began providing another direct source of funds. It instituted what it calls a Term Auction Facility (TAF), a temporary program whereby short-term funds can be obtained on an auction basis using a broad range of collateral including mortgage-related securities.
Today, the Fed announced that it is increasing the amount of funds it auctions each month. The central bank also said that it is expanding its repurchase agreement operation so that more funds can be injected into the monetary system. The actions help ease credit concerns and have the effect of lowering borrowing rates.
But analysts note that the latest actions dilute the argument for aggressive rate cuts at the regular policy meeting on the 18th or for a surprise cut between now and then. The fact that stocks are holding up under the weight of the employment news is also reducing the usual tendency of traders shifting into Treasuries.
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