Should You Pay Discount Points on a VA Loan?

A VA loan offers military service members, veterans, and eligible surviving spouses a path to homeownership with unique benefits. Among mortgage considerations, paying “discount points” often arises. Understanding how these points function within the VA loan framework influences both upfront costs and long-term financial commitments.

Understanding Discount Points on a VA Loan

Discount points are an upfront fee paid to the mortgage lender for a reduced interest rate over the loan’s life. This financial tool is common in mortgage lending, and its application to VA loans is similar. One discount point is equivalent to one percent of the total loan amount. For instance, on a $300,000 loan, one point would cost $3,000.

Points are paid at loan closing. While interest rate reduction varies by lender and market conditions, one point commonly lowers the rate by approximately 0.25 percent. For VA purchase loans, discount points must be paid in cash at closing and cannot be rolled into the loan amount. However, for a VA Interest Rate Reduction Refinance Loan (IRRRL), up to two points can be included in the loan.

Lenders may permit the purchase of more than one point, though most cap the total at around four points. While borrowers cover these costs, sellers can contribute to a buyer’s closing costs, including funds for points, through seller concessions up to four percent of the purchase price. Additionally, under IRS guidelines, discount points paid by the borrower for a primary residence may be tax deductible.

Analyzing the Financial Trade-Off

Paying discount points involves assessing long-term savings versus immediate outlay. The primary calculation is the “break-even point,” indicating how long monthly interest savings will take to offset the initial cost of points. This calculation determines if the upfront investment is financially advantageous based on how long a borrower expects to keep the loan.

To calculate the break-even point, divide the total cost of the discount points by the amount saved on the monthly interest payment. For example, consider a $300,000 VA loan with an initial interest rate of 6.00 percent, resulting in a principal and interest payment of approximately $1,798 per month over 30 years. If paying one discount point (costing $3,000) reduces the interest rate to 5.75 percent, the new monthly payment would be around $1,749.

In this scenario, the monthly interest savings would be $49 ($1,798 – $1,749). To find the break-even point, divide the $3,000 cost of the point by the $49 monthly savings, which equals approximately 61 months, or just over five years. If the loan is kept for longer than this five-year period, the borrower will save more in interest than they paid for the point. Conversely, if the loan is paid off or refinanced before the break-even point, the borrower would not fully recoup the cost of the points.

Factors Guiding Your Decision

Paying discount points depends on personal and financial circumstances. Considering these factors helps borrowers determine if the upfront cost aligns with their financial strategy and homeownership plans. A key element is the anticipated length of stay in the home.

If a borrower plans to live in the home for an extended period beyond the calculated break-even point, paying points can lead to substantial long-term interest savings. For those who foresee selling the home or refinancing the loan within a few years, the benefit of a lower interest rate may not outweigh the initial expense.

Borrower’s current financial liquidity also plays a role. Paying points requires cash upfront at closing, so sufficient reserves are important to cover this cost without straining overall finances.

The prevailing interest rate environment can also influence this decision. In periods of higher interest rates, securing a lower rate through discount points can be particularly appealing, as the monthly savings might be more significant. Conversely, when interest rates are already low, the impact of buying down the rate might be less pronounced, and the break-even period could extend. A borrower’s future financial outlook, including job stability and potential income changes, should also be considered, as a stable financial future makes the long-term commitment of paying points more manageable.

Alternative Approaches and VA Loan Specifics

When considering discount points, be aware of alternative mortgage strategies and unique aspects of VA loans. One alternative is a “no-points loan,” where a borrower accepts a slightly higher interest rate in exchange for not paying upfront discount points. This option can be suitable for those who prefer to minimize their cash outlay at closing.

Another approach involves “lender credits,” which operate opposite to discount points. With lender credits, the lender provides a credit toward closing costs, reducing the amount of cash needed at closing. In return, the borrower agrees to a slightly higher interest rate over the loan’s term. This can be beneficial for borrowers with limited funds for closing, though it results in higher monthly payments.

A distinct feature of VA loans is the VA Funding Fee, a one-time charge paid to the Department of Veterans Affairs. This fee helps sustain the VA loan program and ranges from 0.5 percent to 3.3 percent of the loan amount, depending on factors such as loan type, down payment, and whether it is the borrower’s first or subsequent use of their VA loan benefit. For instance, a first-time VA loan user with less than a five percent down payment would pay a 2.15 percent funding fee in 2025, while a subsequent user might pay 3.3 percent. This fee can be paid upfront or financed into the loan, influencing the total amount borrowed and the cash needed at closing. However, some veterans, such as those receiving compensation for service-connected disabilities, are exempt from paying this fee.

VA loans do not require private mortgage insurance (PMI), a significant advantage compared to conventional loans, especially when a borrower makes a down payment of less than 20 percent. The VA’s guarantee to the lender effectively replaces the need for PMI, potentially saving borrowers a substantial amount in monthly payments over the life of the loan. This absence of PMI is a considerable cost saving that influences the overall financial benefit analysis when deciding whether to pay discount points.