What’s the Point of Paying Points?
VA interest rates are not set by the government. They are determined by private mortgage lenders and vary. In fact, the Veterans Administration recommends that you obtain several VA home loan quotes from competing lenders and choose the best offer. Once you have chosen your lender, you'll need to select a rate and cost that works best for you and decide if it makes sense to pay discounts points.
What's a Discount Point?
Discount points are charged by lenders for providing a lower mortgage rate. They are considered prepaid interest because the borrower pays upfront to have a lower rate during the term of the loan. Paying discount points to get a lower rate is called "buying down" your interest rate.
One discount point is equal to one percent of the mortgage amount – for example, one discount point for a $200,000 loan is $2000. If you choose to wrap your VA funding fee into your loan amount, discount points are calculated from the base loan amount plus the funding fee.
Should You Pay Discount Points?
When shopping for a mortgage, you'll be able to choose between home loans with a variety of closing costs and interest rates. Here's a sample of what was available in early February 2015 for a VA-eligible borrower with excellent credit.
Notice that the higher the loan costs, the lower the interest rate. But how do you know if lower payments tomorrow are worth paying for discount points today? You can easily calculate how long it will take for lower payments to offset the upfront cost of discount points. You'll first subtract the lower payment of the more expensive loan from the higher payment of the no-cost loan. In the example below, that's $1,706.37 – $1,679.97, which is $26.40 per month. Divide the cost of getting that lower payment (in this case, it's $3,800) by the difference in payment (the $26.40), and you get 144 months, or 12 years. So you'd have to keep your VA loan longer than 12 years for buying the rate down to 3.375 percent worthwhile. The table below shows breakeven points for several VA loan rates and pricing structures.
Paying or Financing Points
- If you're purchasing a home, you won't be allowed to finance your loan fees including discount points. However, the VA allows home sellers to pay up to two discount points for you.
- If you're refinancing, you may be able to add up to two discount points to your loan amount. Understand, though, that doing this extends your breakeven point.
- For interest rate reduction refinance loans (IRRRL), a maximum of two discount points can be added to the VA loan amount; additional points must be paid in cash at closing.
- While VA guidelines don't allow discount points to be rolled into the loan amount for a cash-out refinance, VA borrowers are permitted to use cash received from refinance proceeds to pay for their discount points.
What's the Point?
In general, it doesn't make sense to buy down an interest rate unless you can get the home's seller to pay them, or the breakeven point is fairly short, or you are absolutely sure that you'll be keeping your loan for many years. However, you may have no choice in the matter if you need a lower-than-market interest rate to qualify for your mortgage.