Can You Buy Down the Interest Rate on a VA Loan?

A VA loan provides significant benefits for eligible veterans, service members, and qualifying surviving spouses, offering favorable terms for homeownership. A common strategy to manage mortgage costs is “buying down the interest rate,” which involves paying an upfront fee to secure a lower interest rate over the loan’s duration. This article examines how this financial tool operates and its implications for VA loan borrowers.

Understanding Discount Points

Discount points represent a form of prepaid interest that a borrower pays directly to the lender at the time of closing. This upfront payment serves to reduce the interest rate applied to the loan for its entire term. The primary purpose of these points is to decrease the overall cost of borrowing and result in lower monthly mortgage payments.

The cost of discount points is calculated as a percentage of the total loan amount. Typically, one discount point equals one percent of the mortgage principal. For instance, on a $300,000 loan, one point would cost $3,000.

In exchange for this upfront payment, lenders usually reduce the interest rate by a certain amount, commonly ranging from 0.125% to 0.25% per point, though this exact reduction can vary by lender and market conditions. Borrowers have the flexibility to purchase whole points or fractional points, depending on their financial goals and the lender’s offerings.

VA Loan Rules for Discount Points

VA loan borrowers are permitted to use discount points to lower their interest rate. The Department of Veterans Affairs (VA) generally allows lenders to charge “reasonable” discount points. While the VA sets no strict maximum for purchase loans, individual lenders often limit points, commonly allowing up to four.

For new VA home purchase loans, discount points paid by the borrower must be paid in cash at closing and cannot be rolled into the loan amount. This differs from the VA funding fee, a separate mandatory charge that can often be financed. Discount points are distinct costs and do not affect the funding fee.

In refinance scenarios, such as a VA Interest Rate Reduction Refinance Loan (IRRRL), specific rules apply. For IRRRLs, a maximum of two discount points can be rolled into the loan; any additional points must be paid out-of-pocket. For VA cash-out refinances, points can be paid from loan proceeds, but all closing costs, including points, must be recouped within approximately 36 months.

Beyond the borrower’s payment, sellers can also contribute towards discount points as part of seller concessions. The VA permits sellers to pay for a buyer’s discount points, and “normal discount points” are explicitly excluded from the VA’s 4% seller concession limit. This allows sellers to cover reasonable discount points in addition to the 4% cap on other concessions. “Normal” points typically refer to up to two points, or potentially three if the lender charges no other origination fees.

Assessing the Financial Implications

Evaluating whether to pay discount points on a VA loan requires a careful financial assessment tailored to an individual’s circumstances. A primary calculation involves determining the “break-even point,” which is the period it takes for the monthly savings from a lower interest rate to offset the upfront cost of the discount points. This is calculated by dividing the total cost of the points by the amount saved on the monthly mortgage payment.

For example, if paying $3,000 in points reduces a monthly payment by $50, the break-even point would be 60 months, or five years. If a homeowner anticipates selling the property or refinancing the loan before reaching this break-even point, paying points would result in a net financial loss. Conversely, staying in the home beyond the break-even period means the borrower will realize net savings over time.

When making this decision, borrowers should consider how long they realistically plan to live in the home or keep the loan. The current interest rate environment can also influence the attractiveness of buying down the rate; in periods of higher rates, savings from points might be more substantial. This analysis helps determine if the upfront investment aligns with long-term financial goals and anticipated homeownership duration.