What is a Graduated Payment?

A graduated payment is a unique repayment plan that calls for the incremental increase in the amount of the regularly scheduled installments associated with a loan. Beginning with a relatively low payment, the amount due each payment cycle gradually increases. The idea behind this type of closed end obligation is that the financial circumstances of the borrower will improve over time, making it possible to manage higher payments at a later point in the life of the loan.

While the terms and conditions that govern a graduated payment approach will vary somewhat, depending on local regulations and standards, most are structured to allow for smaller monthly payments for the first one to two years of the loan. After that, the amount of the monthly installment increases by a certain percentage, and remains at that level for a specified period of time. Some loans structured in this manner may have as many as five levels or tiers of installment amounts that apply over the life of the loan.

Repayment terms of this type are not unusual, especially when it comes to business loans. For example, a new business that is just starting up will find that a graduated payment format makes it much easier to remain current on its financial obligations as it works toward becoming profitable. Assuming that the business is successful in attracting customers and begins to generate higher amounts of revenue before the first scheduled increase in the monthly installment amount, the business gets the benefit of using the proceeds from the loan, but never experiences any hardship in repaying the loan on time and in full.

There are situations in which a graduated payment may be used as part of a home mortgage. While this is not as common as with loans to businesses, the process is still basically the same. The terms of the contract allow the homeowner to enjoy monthly installment payments that are lower during the first phase of the mortgage. In the best of circumstances, this allows the homeowner to defer the higher payments while he or she positions the household finances to accommodate a higher monthly mortgage payment, usually by paying off credit cards or other loans in the interim.

As with any type of payment strategy, a loan structured with a graduated payment plan usually includes provisions that help to protect both the lender and the debtor. In the event that the borrower falls behind on the payment schedule, the lender may have the right to increase the amount of interest due on the outstanding balance of the loan. The lender may also have the right to cancel the graduated payment altogether and convert the loan into one with a uniform monthly installment payment for the life of the loan. When this takes place, the lender is likely to use the installment amount that applies to the last tier of the repayment schedule as the figure for the new installment schedule.