While recapping the basics of VA loans, we talked about graduated payment mortgage or GPM. GPMs, as noted in the article, involve one of those rare scenarios where a down payment is required on a VA loan.
But, what is a graduated payment mortgage? If you were a Veteran, should you count it as an option when buying a home?
Graduated Payment Mortgage: How it Works
GPMs are one of those loans that require special underwriting per VA guidelines. This “special” designation has to do with the way these mortgages are being paid off or their amortization scheme.
In a GPM, a portion of the mortgage’s interest is deferred every month and is added to its unpaid principal balance during a graduation period.
While both have the effect of lowering the monthly payments, they ultimately increase the outstanding loan balance, leading to negative amortization.
The payoff schedule of the GPM is summarized as:
- Its monthly payments initially are lower than payments on a similar mortgage with standard amortization.
- Its monthly payments will then increase periodically at a fixed percentage for a graduation period.
- The increase is 7.5% per year for the first five years. On the sixth year, the payments will level off and will remain the same throughout the life of the GPM. This results in higher payments post-level-off period.
Who Then Qualifies for GPM or Should Consider It As an Option?
The way it works, GPMs are not exactly for everyone. As VA counsels, these mortgages should only be used as an alternative for eligible Veterans whose income is bound to increase at the same rate as the increase in payments of the GPM. Their income should be able to support higher payments on the mortgage after its leveling-off period.
VA thus warns against using GPMs to qualify Veterans who don’t qualify for loans with standard amortization.
Key Features of Graduated Payment Mortgage
If you qualify for a GPM, here are important points to remember:
1. For purchase transactions only.
It is used solely to buy a single-family home that is not a manufactured home.
The GPM can’t be used to refinance another loan, finance repairs, or acquire a multi-family property. However, a fixed-rate VA refinance loan can be used to refinance the GPM.
2. The need for down payment.
The GPM’s principal loan amount may not exceed the initial reasonable value of the property.
But as noted above, the principal is expected to increase at some point, violating the above provision.
To offset this risk, down payment is required. Lenders refer to HUD tables in calculating down payments on VA’s graduated payment mortgages.
Simply put, the down payment is the difference between the maximum initial loan amount and the property’s initial reasonable value.
3. The down payment and the type of property.
Whether the property is new construction or existing but not previously occupied, the maximum initial loan amount may not exceed (a) the home’s purchase price or (b) 97.50% of the property’s initial reasonable value, whichever is lower.
The down payment will then take care of the difference between the initial loan amount and the initial reasonable value.
4. The choice for a bigger down payment.
The borrower (that’s you) can choose to put a large down payment to offset the negative amortization. But it must be paid in cash out of one’s pocket.
5. Rate increase = recalculation.
The increase in the interest rate of the graduated payment mortgage involves recalculating the loan’s maximum amount, down payment, and payment schedule.
6. The inclusions of the initial loan amount.
The initial loan amount may include VA’s funding fee and energy efficiency improvements, as noted earlier.
If you are amenable to the terms above and more (as the lender will explain to you), you will sign a statement noting that you fully understand the obligation of taking on the graduated payment mortgage.
For more questions, feel free to contact a VA approved lender.