25 Feb What’s the Point of Paying Points?
Discount Points and Your VA Home Loan
Since the VA is not the lender of your VA Mortgage, they do not set the terms of your loan. Instead, the terms are set by the private leader who issues the loan. Because of this, the Department of Veteran Affairs insists that borrowers shop for multiple quotes for a VA Loan before selecting the best option. After you have your lender selected, you now have the choice of settling on an interest rate and determining if paying discount points is the best choice for you.
Talking about discount points
Discount points are essentially prepaying a certain amount of your interest. In order to give a borrower a lower interest rate, the lender will charge you discount points. This is considered “buying down” your interest rate, since you are making a payment upfront in order to obtain a lower rate throughout the life of your loan.
Each percentage of your loan is the same as one discount point. If you select to roll the VA funding fee into your mortgage, the total amount, mortgage plus funding fee, is used to determine the amount of each discount point. As an example, if the total amount of your loan (with funding fee, if applicable) is $300,000, then one discount point is $3,000.
Deciding if discount points are right for you
There are an assortment of interest rates and closing costs available when looking around for a mortgage. Below is a snapshot of what a VA Mortgage borrower with great credit would qualify for as of early 2015.
|Interest Rate||Origination Percentage||Discount Points Percentage||Total Fee Percentage|
As you can see, with the lower interest rates, you will have to pay more in origination fees and discount point. So, how can you determine if paying more upfront will lead to paying less over the life of your loan? There is a simple calculation to figure out how much time it will take for the lowered monthly payments to justify paying for discount points upfront. Here it is:
(Payment amount of higher interest rate loan) – (Payment amount of lower interest amount loan) = X
(Total loan fees) ÷ X = Number of months it will take before discount points offset lower payments
Here’s how the calculation would work out in the example below:
1,706.37 – 1,679.97 = 26.40
3,800 ÷ 26.40 = 144 months – or – 12 years
So, in this scenario, it would take the borrower 12 years to breakeven, which means they would have to have the VA Loan for that amount of time in order for the deal to make sense. Here are more scenarios and how they would playout with discount points.
|Interest Rate||Loan Fees||Monthly Payments||Years to Breakeven|
What are your options when it comes to including discount points in with the loan?
- The Department of Veterans Affairs will allow terms that request the seller to pay for as many as 2 discount points for the borrower (buyer)
- You are not able to include loan fees and discount points in with your VA Loan financing
- With a refinance loan, you could be eligible to roll as many as 2 discount points into the overall loan amount. Keep in mind, though, this will extend the time period until you breakeven
- Cash-Out Refinance loans are not eligible to have discount points included in the overall loan amount. However, borrowers who refinance with this option may us the cash they receive back from this program to purchase discount points
- Borrowers who use the Streamline or IRRRL Refinance program, are eligible to roll up to 2 discount points into the overall loan amount with further discount points to be purchased in cash at the time of closing
Should you or should you not?
Overall, purchasing discount points will not benefit you unless one of these scenarios is present:
- The home sellers will agree to pay them for you
- You will be staying with your loan for longer than the breakeven point
- Your breakeven point is only a handful of years
If you must have an interest rate that is below-market in order to qualify for your loan, the only option you may have is to purchase discount points. If this is the case, talk to your loan specialist about your specific situation.