The graduated payment mortgage (GPM)

With a graduated payment mortgage (GPM), payments increase periodically by predetermined amounts until the payment fully amortizes the principal over the remaining life of the mortgage without a further increase in payments, the interest rate on the note being fixed.

GPMs are in demand when interest rates or home prices rise too quickly and ARMs are disfavored by the buyer. The graduated payment schedule allows buyers time for their income to increase and cover mortgage payments when they reach the level that will fully amortize the principal without a further graduation in payments.

For example, a borrower takes out a GPM. The initial low monthly payments on origination are less than the interest that accrues on the principal balance. The payments are gradually increased over the first three to five years of the mortgage until the payment amortizes the principal over the remaining term.

However, the monthly interest accrued and remaining unpaid each month is added to the principal balance. This results in negative amortization since the principal is increasing rather than decreasing with each payment. Thus, the negative amortization causes the unpaid interest to bear interest as principal, called compounding.

The all-inclusive trust deed (AITD)

The all-inclusive trust deed (AITD) variation of a note is common in carryback transactions. The AITD note, also known as a wraparound or overriding note, typically calls for the buyer to pay the carryback seller constant monthly installments of principal and interest. The carryback seller then pays the installments as they become due on the underlying (senior) mortgage, generally out of the payments received on the AITD note.

AITDs become popular in times of recession and rising mortgage rates due to tight credit.

For the benefit of the seller, the AITD:

  • allows a greater yield than ordinarily can be negotiated for the note rate on a regular second mortgage, a financial advantage generated by the overriding interest rate feature available by use of an all-inclusive note;
  • eliminates the risk of loss due to a default on the underlying mortgage since the seller remains responsible for its payment;
  • defers profit tax liability for a greater percentage of the transaction’s profit since an all-inclusive note increases the percentage of profit allocated to the principal in the carryback mortgage;
  • supports the price sought by the seller by providing non-institutional financing; and
  • provides for a trustee’s foreclosure on the buyer’s default, unlike other wraparound security devices, such as land sales contracts and purchase/lease-option agreements which require a judicial foreclosure (unless they contain a power-of-sale provision).

An AITD is always a junior mortgage, usually a second, subordinate to a pre-existing, underlying first mortgage. Legally, the AITD has the same function as a regular trust deed.

The AITD form used is a regular trust deed form with the addition of an AITD addendum. The AITD addendum covers the disclosures and accounting for the financial aspects unique to an AITD. [See RPI Form 442, 443 and 450]

Like the AITD, land sales contracts and lease-option sales are also all-inclusive security devices which exhibit the same wraparound debtor/creditor features. Under all three, the seller has sold the property yet remains responsible for payments on the underlying mortgage while receiving installments from the buyer. Additionally, income and property tax results for each device are treated the same by all government agencies.