How to Use Discount Points to Lower the Rate on Your VA Loan

In a previous article, we explained some of the ways a borrower could save money when using a VA loan to buy a house. One of those strategies involved paying discount points in order to reduce total interest costs over time. 

Today, we will zoom in on this topic to explain how you could use discount points to secure a lower mortgage rate on your VA loan. This strategy could result in significant savings over time, especially if you plan to keep the loan for many years. 

What are Discount Points? 

Discount points (a.k.a, mortgage points or prepaid interest) are fees that a borrower pays to a lender upfront in order to lower the interest rate on the loan. Each point is generally equal to 1% of the loan amount. For example, one point on a $400,000 loan would cost $4,000, two points would cost $6,000, and so on. 

Discount points can be coupled to lower the VA loan interest rate further. Each point purchased typically reduces the interest rate by 0.25%. 

“Buying down” the interest rate by paying discount points can be a good financial decision for borrowers who plan to stay in their homes for a long time. The upfront cost of discount points can be offset by long-term savings on interest payments. 

Discount points can be applied to both VA and conventional mortgage loans. In both cases, the goal is the same. The borrower is choosing to pay more money upfront, at closing, to secure a lower interest rate over the long term (and ultimately save money). 

But discount points aren’t suitable for every home buyer who uses a VA loan. A bit later, we will explore the times when it might make sense to use discount points with a VA loan and scenarios when it does not. 

Benefits of Using Them on a VA Loan 

The biggest advantage of using discount points with a VA loan is cheaper interest rates. As previously stated, each discount point normally decreases the interest rate by 0.25%. This can lead to considerable savings throughout the life of the loan.  

For example, purchasing one discount point on a $400,000 VA loan might reduce the interest rate by 0.25%, saving the borrower around $120 per month on their mortgage payment. Over the course of 30 years, this may save you more than $43,200 on interest.  

Discount points, which decrease the interest rate, can help borrowers save a great amount of money over the course of their loan. The actual amount of savings depends on the loan amount, interest rate, and the number of discount points obtained. However, even a tiny rate reduction might result in large savings over time.  

Borrowers may utilize a mortgage calculator or seek a mortgage lender to determine the possible savings from purchasing discount points on a VA loan. Borrowers may use online mortgage calculators to determine their monthly payments and total interest costs by entering their loan amount, preferred interest rate, and term length. 

However, a mortgage lender may be able to provide a more personalized estimate by analyzing the special variables of the borrower’s financial condition and loan details. 

When Should You Consider Using Discount Points? 

Borrowers looking to cut down their mortgage interest rates and save money over the course of their loans may find that discount points are a useful tool. However, you should think about your long-term aspirations for homeownership, your present financial status, and your mortgage financing goals before employing them.  

The following circumstances allow borrowers to take advantage of VA loan discount points.  

• Long-term Homeownership: Due to the compounding impact of reduced interest rates, discount points can offer considerable long-term savings if you expect to stay in your house for a long time.  
• Reducing Monthly Payments: By decreasing the interest rate, discount points can significantly cut your monthly mortgage payments if that’s your goal.  
• Financial Flexibility: Investing in discount points might be a wise move to reduce your total mortgage expenses if you have the initial cash on hand.  

However, in the following situations, this tactic might not be appropriate:  

• Insufficient Seeding Capital: The purchase of discount points could not be affordable if you have inadequate initial cash.  
• Ownership for a Short Period of Time: Should you want to sell your house in a few years, you might not have enough time to save enough interest to cover the initial cost of the discount points.  
• Financial Limitations: You may find that the cost of discount points conflicts with your other financial priorities, such as preparing for retirement or your child’s school. 

The choice is going to rely on your long-term goals and funding priorities. Use VA loan discount points if you wish to lower your monthly installments and overall interest charges if you want to remain in the house for a long time! 

Occasionally, it could be more cost-effective to add to your down payment rather than pay for discount points, particularly if doing so raises it to the 20% mark, which removes the requirement for mortgage insurance. 

Evaluate Your Needs Before Utilizing Discount Points 

When shopping around for mortgage discount points, a range of interest rates and closing expenses are available. 

You’ll probably have to spend more on origination fees and discount points because of the lower interest rates. Thus, how can you ascertain whether larger upfront payments would result in lower total loan payments over time?  

The amount of time it will take for the reduced monthly payments to balance the upfront cost of the discount points on a VA loan may be calculated easily. This is: 

(Loan payment amount at higher interest rate) – Loan payment amount at lower interest rate = X  

(Total loan fees) ÷ X = Months until lower payments are offset by discount points 

Since a borrower who pays for points “has to think long and hard about refinancing,” discount points might not be advantageous to everyone. They risk losing money if they haven’t yet recovered the cost of those points, and they’ll also be responsible for the extra fees and closing costs associated with refinancing. 

Investors are prepared to tolerate lower interest rates because of the possibility of longer returns. If a lender offers you a reduced rate, remember this and make sure the points benefit you as well as the investor. 

Guidelines To Follow When Using Discount Points 

To avail of the benefits of a VA mortgage loan with discount points, you must adhere to these guidelines set by the authorities. 

• Terms requesting the seller to cover up to two discount points for the borrower (buyer) are permitted by the Department of Veterans Affairs. 

• Loan costs and discount points cannot be included with your VA finance for loans. 
• You may be able to roll over up to two discount points into the total loan amount when you refinance. However, remember that doing so will lengthen your time to break even. 
• Discount points cannot be added to the total loan amount for Cash-Out Refinance loans. But if they choose this option for refinancing, borrowers can utilize the money they get back from the scheme to buy discount points. 
• Up to two discount points can be rolled into the total loan amount for borrowers who use the Streamline or IRRRL Refinance program. Additional discount points can be acquired with cash at the closing. 

Rolling Them Into the Loan 

VA loan home buyers often want to know if they can finance the discount points into the loan and pay them off over time. The short answer is no. 

The Department of Veterans Affairs allows homeowners refinancing a VA loan to finance up to two points into the loan amount. But in a purchase scenario, the home buyer must pay the discount points at or before the closing. 

As it states on the VA.gov website: “Discount points may be rolled into the loan only in the case of refinancing loans…” 

Here are the key points to take away from all of this: 

When using a VA loan to buy a house, you have the option to pay mortgage discount points at closing. 

This strategy allows you to reduce or “buy down” your mortgage interest rate. 

The size of the rate reduction will depend on the number of points you pay at closing and other factors. 

By helping you secure a lower rate, discount points can reduce the size of your monthly payments and the total amount of interest paid over the life of the loan. 

This strategy typically works best when a person stays home and keeps the loan for more than five years, but this can vary. 

Paying mortgage discount points on a VA loan requires a trade-off. The borrower must come up with more funds at closing, but they could save a significant amount of money over time.