Home buyers looking for alternatives to the current fixed-rate mortgages, which have doubled in the past 12 months, find themselves with limited options for lower payment options. Recently we covered one of the most touted options: the 2-1 buydown.
There is another option that may be less costly overall and yet provides a way for buyers to ease into home ownership without facing the considerable sticker shock they are facing with current rates. That alternative is offered by FHA under Section 245(a).
Overview of the FHA Section 245(a) program
The Federal Housing Administration (FHA) insures GPM loans through its Section 245(a) program. This program was created to help homebuyers with limited cash resources afford a home by offering a graduated payment structure that allows for an initial lower mortgage payment that gradually increases over time. The FHA also sets specific guidelines for eligibility, including income and credit requirements and a borrower’s ability to repay the loan.
What are Graduated Payment Mortgages (GPMs)?
GPM loans through the FHA Section 245(a) program are a valuable option for homebuyers with limited cash resources and who expect their income to increase significantly over time.
Graduated Payment Mortgages (GPMs) allow for an initial lower mortgage payment that gradually increases over time, with the goal of reaching a market-rate payment within 5 or ten years, depending on which of 5 options available the borrower chooses.
This gradual increase in payments is based on the borrower’s current and projected income growth and is intended to help the borrower afford the mortgage payments as their income increases.
Eligibility for GPMs
To be eligible for a GPM loan through the FHA Section 245(a) program, borrowers must meet the standard FHA requirements: have a stable income, a good credit history, and the ability to repay the loan. These criteria are put in place to ensure that the borrower is able to afford the mortgage payments as they increase over time and are able to repay the loan as agreed.
Under the FHA Section 245(a) program, borrowers must have a stable income and demonstrate that their income is expected to increase over time. The FHA uses the borrower’s current income and employment history to determine their ability to repay the loan and may require documentation such as pay stubs, W-2 forms, and tax returns.
Credit history requirements
A borrower’s credit history is also considered when determining eligibility for a GPM loan. The FHA looks for a history of timely payments and a credit score that meets their guidelines. Borrowers with a low credit score or a history of late payments may not qualify for a GPM loan.
Ability to repay the loan
Graduated Payment Mortgages are Qualified Mortgages which means lenders are required to evaluate and meet the borrower’s “Ability To Repay” rule. The FHA also considers other factors, such as the borrower’s assets and reserves, as well as their employment history and stability.
Benefits of GPM Loans
Ability to purchase a home with a lower initial monthly payment
One of the main benefits of GPM loans is the ability to purchase a home with a lower initial mortgage payment. This can make it more affordable for borrowers with limited resources to enter the housing market and become homeowners. This can also make it possible for borrowers to qualify for a larger loan to buy a bigger home, as the initial payments are lower.
Gradual increase in payments reduces default risk
Another benefit of GPM loans is that the gradual increase in payments is designed to help borrowers avoid the risk of default as their income increases. The payments will gradually increase over time, typically every five to ten years, which allows the borrower to adjust to the higher payments as their income increases. This helps to ensure that the borrower will be able to afford the mortgage payments and will be able to repay the loan in full.
Unlike the 2-1 buydowns that seem to be the talk of the market and adjust to the full rate payment in just two years, a GPM borrower can opt to have their payments increase gradually over five or ten years before they hit the full monthly payment.
Suitable for borrowers with limited cash resources
GPM loans are particularly suitable for borrowers with limited cash and income resources, as the lower initial payments make it more affordable for them to enter the housing market. Additionally, the gradual increase in payments is designed to help these borrowers avoid the risk of default as their income increases, which can provide peace of mind and stability for the borrowers.
Drawbacks of GPMs
The borrower’s income projections may happen differently than planned
Although this is not a drawback of any of the features of the program, borrowers who plan on making future payments at a higher amount based on the projected growth of income may find that their income does not grow as planned. This will cause them to struggle to make higher payments when they increase.
The loan balance may grow over time
Another potential drawback of GPM loans is that the loan balance may grow over time if the borrower only pays the minimum required payment. GPMs allow the borrower to make smaller payments through negative amortization, meaning that any portion of the full payment based on the note rate not made by the minimum payment will be added to the loan principal.
Not suitable for all borrowers
GPM loans may not be suitable for all borrowers. For example, borrowers with a stable income that is unlikely to increase, or those who prefer to have fixed mortgage payments throughout the loan period, may not benefit from the graduated payment structure.
FHA Section 245(a) Graduated Payment Mortgages (GPMs) are a useful option for homebuyers who expect their income to increase significantly over time and have limited ability to pay a regular 30-year fixed payment at the going rates. The GPM loan program allows for an initial lower mortgage payment that gradually increases over time, with the goal of reaching a market-rate payment by the end of the loan term. This gradual increase in payments is based on the borrower’s projected income growth and is intended to help the borrower afford the mortgage payments as their income increases.
GPMs also give borrowers the option of buying a house in a competitive environment because no seller concessions are required for a GPM. Unlike 2-1 buydowns which require that the subsidy between the full payment and the short-term lower payment be paid for by either seller or buyer, GPMs do not require that. This makes a buyer’s offer more competitive in the marketplace.