Deciphering the VA Lender’s Handbook Chapter 7 Part 14
We’re still powering through chapter 7 of the Handbook, and after covering joint loans, Energy Efficient Mortgages, supplemental loans, and adjustable-rate mortgages, we’re getting started with graduated payment mortgages (GPMs). There’s a fair amount of information in the Handbook about GPMs, presumably because they are commonly asked after and are truly a different beast from other types of mortgages. This is the first of several articles that will cover everything the Handbook has on GPMs.
So what on earth is a GPM? A GPM is a mortgage option with unique amortization features. Where the terms ARM and fixed-rate mortgage refer to the interest rate on a loan, terms including GPM and GEM (will be covered in future articles) refer to the amortization schedule on a loan. On a GPM, the basic idea is to start out the loan by making smaller payments, which are periodically increased over a period of time referred to as the “graduation period”, until they reach a maximum level which is carried through the rest of the loan. This graduated payment plan is very different from a standard amortization schedule. Compared to a standard amortization plan, the initial payments on a GPM are lower, then during the graduation period eventually get higher, and rest at a higher payment for the remainder of the loan after the graduation period.
A GPM is a unique beast because it involves what is called “negative amortization”. Negative amortization is when less is being paid off the loan than is being added to it by interest. In other words, the interest each month is adding more to the balance owed on the loan than you are paying off at the beginning. The unpaid interest gets added to the principal and is paid off as part of the higher monthly payments in the latter part of the loan. This is a distinct disadvantage of a GPM – you end up paying more in interest (sometimes a good deal more) in exchange for the lower monthly payments at the beginning.
So when should a GPM be used? Well, for a person intending to buy and “flip” a house, selling it just one or two years after purchasing it, a GPM allows them to take less out of their pocket to pay the mortgage each month and leave more money for the renovations they are doing, which allows them to sell the house faster, saving them in interest overall. One of the more common use cases is for a veteran whose income at the moment is not sufficient to cover a fully-amortizing monthly payment, but can reasonably expect their income to increase enough to cover them later on (perhaps the veteran is graduating from college in the next couple years). The VA specifically mentions that the GPM should not be used in these cases unless there is a reasonable expectation that the borrower’s income will increase as needed to cover the monthly payments.
There are some special rules about what a GPM can be used for. A GPM can only be used to purchase a single-family unit (no duplexes or quadplexes; too much risk), but can include an energy efficiency mortgage of up to $6,000 on top of it. A GPM can not be used to purchase a manufactured home – even if it has a permanent foundation. GPMs cannot be used to refinance a property, make alterations or repairs, and certainly not for improvements.
There is an inherent risk to a lender (and, therefore, the VA) when they approve a GPM. When the payments get higher, is the borrower going to be able to keep up with them? What if the borrower’s income does not get higher as planned? GPMs can be not only a headache for lenders, but potentially the cause of a substantial loss as well. For borrowers, however, it can be the difference between home-ownership and perpetual renting. If you think a GPM might be for you, ask around to different lenders to see if it’s an option. You may have a hard time finding a lender that offers GPMs, but on the other hand, you may not.