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As with a conventional loan, it's possible to buy down points on a VA loan to reduce your interest rate. However, it's critical to understand both the costs and the benefits of buying discount points and whether it's the right fit for you.
It's also important to note that as mortgage rates have fallen to historic lows in 2020 and the beginning of 2021, the benefits of purchasing VA loan points may not be as pronounced as they are during times when interest rates are high.
How Does Buying Down Points on a VA Loan Work?
A VA loan is a specialized mortgage loan that's guaranteed by the U.S. Department of Veterans Affairs. This means that the lender is protected if the borrower can't make their monthly payments.
VA loans have strict eligibility requirements, effectively making them available only to select members of the military community.
It's possible to purchase discount points on a VA loan, which is essentially the same as paying prepaid interest. In exchange for an upfront payment at closing, the lender will reduce the interest rate on your loan.
For the most part, the process is similar to buying points on a conventional loan. However, there are some differences, depending on the type of loan you choose:
- If you're buying a home, you can't roll your points into the loan.
- The seller is allowed to pay up to 4% of the loan amount toward your closing costs, which doesn't include discount points, but it could free up some cash for you to buy them.
- With a VA interest rate reduction refinance loan (IRRRL), you can roll the cost of up to two discount points into the loan, but your total loan fees must be recouped in 36 months or less to qualify.
- If you want a VA cash-out refinance, you can roll closing costs, including discount points, into your loan as long as the loan-to-value ratio doesn't exceed 90%. Also, your break-even point on closing costs must be 36 months or less.
If you're thinking of getting a VA loan and want to understand your options with buying points, speak with your lender to get information specific to your situation.
How to Calculate VA Mortgage Points
The cost of a discount point is typically 1% of the loan amount, and it buys down the rate by 0.25%. So, let's say you have a $300,000 loan with a 3.5% fixed interest rate. With a 30-year mortgage, your monthly payment would be $1,347.
Now, if you wanted to purchase one point, it'd cost you $3,000, and it would reduce your rate to 3.25%. To find out if it's worth it, you'd need to determine the monthly payment at the lower interest rate, which is $1,306. Then, you'd divide the cost of the point by the difference between the monthly payments.
In this scenario, that would be $3,000 divided by $41, which gives you a break-even point of about 73 months. In other words, you'd need to remain in the home and not refinance for a little more than six years to make buying the point worth it.
Now, let's say you only want to purchase half a point. That would cost you $1,500, and it would reduce your rate to 3.375%. The difference in monthly payments with this option would be $21, and your break-even point would be about 71½ months.
When Does It Make Sense to Buy Down Points on a VA Loan?
The break-even point is a good place to start when deciding if you should buy discount points on your VA loan. However, there are also other factors to consider to determine if it makes sense for you:
- You can get a concession from the seller to pay for some of your closing costs to help you afford discount points.
- You can afford to pay the cost upfront on a purchase loan.
- You plan to stay in the home long enough to reach the break-even point.
- On a refinance loan, your loan terms satisfy the requirements of the government agency.
On the flip side, buying VA loan points may be a bad decision if:
- You can't afford to make the upfront payment.
- You're not planning on staying in the home long enough.
- Your refinance loan terms don't meet the VA's requirements.
- Interest rates are already low, and the potential savings aren't worth it to you.
As with any financial decision, it's crucial that you take the time to consider your options, including their pros and cons, to ensure that you make the right decision.
How to Buy VA Mortgage Points
You can typically purchase VA mortgage points from your loan provider. Limits can vary based on what the lender offers, as well as limits in place by the VA. As you go through the mortgage process, speak with your loan officer or broker about purchasing discount points, and ask them to provide you with the cost and savings, so you can calculate the break-even point.
If you're on the fence about buying VA loan points, here are some alternatives that could help reduce your interest costs:
- Talk to your lender about making semi-monthly payments to limit the impact of compounding interest.
- Make extra payments each month toward your principal loan amount (though take note of prepayment penalties if the lender charges them).
- Apply for a loan with a shorter term—a 20-year or 15-year loan will give you a higher monthly payment, but if you can afford it, it'll result in less total interest.
Again, take your time to research each option and speak with your lender to get as much information as possible to make a decision.
Building Credit Can Help You Maximize Savings
Buying discount points on a VA loan can help drive down the cost of your monthly payment, but that comes at the cost of an upfront payment at closing. In addition to shopping around to find the best rate, it's important to make sure your credit history is in good shape before you apply for a mortgage.
Establishing an excellent credit score will give you access to lower interest rates because it shows that you're a responsible borrower and a low risk of default.
Check your credit score to see where you stand and review your credit report to get an idea of whether you need to address any issues. If your credit file needs some work, take the time to do it before you apply. This process can take time, but the savings can be in the thousands or even tens of thousands of dollars over the life of the loan.