Can You Buy Down Points on a VA Loan?

It is possible to “buy down” points on a VA loan, a strategy that can reduce the interest rate over the life of the mortgage. This option allows eligible military borrowers to lower their monthly mortgage payments and potentially decrease the total interest paid on their home loan. This approach involves paying an upfront fee in exchange for a more favorable interest rate.

Understanding Mortgage Points

Mortgage points, also known as discount points, are fees paid directly to the lender at closing in exchange for a reduced interest rate on a home loan. These points are a form of prepaid interest. One discount point typically equals one percent of the total loan amount. For example, on a $300,000 loan, one point would cost $3,000.

The primary purpose of paying discount points is to lower the interest rate applied to the loan. A lower interest rate results in reduced monthly mortgage payments and a decrease in the total interest paid over the loan’s term. While the exact reduction in interest rate for each point can vary by lender and market conditions, a common guideline is that one point might reduce the interest rate by approximately 0.25%.

VA Loan Specifics for Discount Points

The Department of Veterans Affairs (VA) permits borrowers to pay discount points on VA-guaranteed loans. This means veterans and service members can utilize this strategy to secure a lower interest rate on their home financing. The VA allows lenders and borrowers to agree upon reasonable discount points.

For VA purchase loans, discount points generally must be paid in cash at closing and cannot be rolled into the loan amount. This means that while a VA loan typically does not require a down payment, opting to pay discount points will add to the cash needed at closing. However, for certain VA refinance loans, such as the VA Interest Rate Reduction Refinance Loan (IRRRL), borrowers may be able to roll up to two discount points into the loan amount.

The VA does not impose a specific maximum on the number of discount points that can be charged, but lenders usually have their own limits, often allowing up to four points. Additionally, while the borrower is responsible for paying points, the VA does allow for seller concessions, where a seller can contribute up to 4% of the loan amount towards certain closing costs, which could indirectly free up borrower cash for points. All discount points and associated costs must be disclosed on official VA loan documents, such as the Loan Estimate and Closing Disclosure.

Calculating and Applying Discount Points

The cost of discount points is directly tied to the loan amount. To calculate the expense, multiply the desired number of points by one percent of the loan principal. For instance, if a borrower takes out a $400,000 VA loan and decides to pay 1.5 discount points, the upfront cost would be $6,000 (1.5% of $400,000).

These upfront costs are typically paid by the borrower at the loan closing, becoming part of the total closing costs. The payment of these points directly influences the interest rate applied to the mortgage. A lower interest rate, secured by paying points, translates into a reduced monthly mortgage payment. For example, a $250,000 loan at 6.00% interest might have a monthly principal and interest payment of approximately $1,499, while that same loan at 5.75% (after paying points) could have a payment of about $1,457, saving $42 per month.

The exact reduction in the interest rate per point can vary, influenced by market conditions and the lender’s pricing structure. Lenders provide precise calculations for how many points are needed to achieve a specific interest rate reduction. The payment of discount points is explicitly detailed on the Closing Disclosure document, which outlines all the final costs associated with the loan.

Evaluating the Financial Impact of Discount Points

When considering whether to pay discount points, a key financial concept to evaluate is the “break-even point.” This point represents the duration, in months, it takes for the monthly savings from a lower interest rate to offset the initial upfront cost of the points. To determine this, divide the total cost of the discount points by the amount saved on the monthly mortgage payment. For example, if paying $3,000 in points saves $50 per month, the break-even point would be 60 months, or five years ($3,000 / $50 = 60).

Several factors influence the break-even point, including the total loan amount, the specific interest rate reduction achieved by paying points, and the borrower’s anticipated loan term. A larger loan amount or a significant rate reduction can shorten the break-even period. Conversely, a smaller loan or minimal rate reduction might extend it.

Paying discount points generally becomes more financially advantageous if the borrower plans to keep the loan for a period longer than the calculated break-even point. This allows the accumulated monthly savings to surpass the initial investment in points, leading to net savings over the life of the loan. If the loan is refinanced or the home is sold before reaching the break-even point, the borrower may not fully recoup the cost of the points.

Mortgage points paid on a primary residence may be tax-deductible as prepaid interest, often in the year they are paid, if the borrower itemizes deductions. However, for refinanced loans, the deduction might need to be spread out over the life of the loan. Borrowers should consult IRS Publication 936 or a tax advisor for specific guidance on the deductibility of points.