Graduated Payment Mortgages

A graduated payment mortgage is a loan where the payment increases predictably each year for a predetermined amount of time (such as 5 or 10 years), then becomes fixed for the remaining duration of the loan.  This loan is referred to as an Option Arm, and the graduated payment schedule is based on a very low "teaser" rate.  But this teaser rate does not necessarily cover the full interest due on the loan, and the unpaid interest is added to the principle of the loan.  This is often referred to as Negative amortization.  

When interest rates are high, borrowers can use a graduated payment mortgage to increase their chances of qualifying for the loan because the initial payment is so much less. The downside of opting for an smaller initial payment is that the interest owed increases and the payment shortfall from the initial years of the loan is then added on to the loan, potentially leading to a situation called "negative amortization." Negative amortization occurs when the loan payment for any period is less than the interest charged over that period, resulting in an increase in the outstanding balance of the loan.

In most areas, these types of loans are no longer available.