Marcus Marion, CMA™ 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 up front, in order to lower the interest rate on the loan. Each point is typically 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 used to further lower the interest rate on a VA loan. 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 the 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 up front, at closing, in order 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 primary benefit of using discount points with a VA loan is lowering the interest rate. As mentioned earlier, each discount point typically reduces the interest rate by 0.25%. This can result in significant savings over the life of the loan.
For instance, buying one discount point on a $400,000 VA loan could lower the interest rate by 0.25%, saving the borrower about $120 per month on their mortgage payment. Over 30 years, this could translate to over $43,200 in interest savings.
By lowering the interest rate, discount points can help borrowers save a substantial amount of money over the life of their loan. The exact amount of savings will depend on the loan amount, interest rate, and the number of discount points purchased. But even a small rate reduction can lead to significant savings over time.
To estimate the potential savings from buying discount points on a VA loan, borrowers can use a mortgage calculator or speak with a mortgage lender. Online mortgage calculators allow borrowers to input their loan amount, desired interest rate, and term length to calculate their monthly payments and total interest costs.
A mortgage lender, on the other hand, can provide a more personalized estimate based on the borrower’s specific financial situation and loan details.
When Should You Consider Using Discount Points?
Discount points can be a valuable tool for borrowers seeking to lower their mortgage interest rates and save money over the life of their loans. But before using them, you’ll want to consider your current financial situation, mortgage financing goals, and long-term plans for homeownership.
Borrowers can benefit from VA loan discount points in the following situations.
- Long-term homeownership: If you plan to stay in your home for an extended period, discount points can provide significant long-term savings due to the compounding effect of lower interest rates.
- Lowering monthly payments: If you’re seeking to reduce your monthly mortgage payments, discount points can effectively lower your payments by lowering the interest rate.
- Financial flexibility: If you have the upfront funds available, discount points can be a worthwhile investment to lower your overall mortgage costs.
On other hand, this strategy might not be suitable in the following scenarios:
- Limited upfront funds: If you have limited upfront funds, the cost of discount points may not be feasible.
- Short-term homeownership: If you plan to sell your home within a few years, you may not have enough time to recoup the upfront cost of discount points through interest savings.
- Financial constraints: If you are budgeting for other financial goals, such as retirement savings or child education, the cost of discount points may not align with your priorities.
Ultimately, the decision will come down to your financing priorities and long-term plans. If you plan to stay in the home for many years and want to reduce your monthly payments and total interest costs, consider using points!
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 who are 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 in the home and keeps the loan 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.
