VA Loan Mastery: Why Paying Points Is Your Financial Edge

Homebuyers frequently purchase mortgage points to lower their interest rate when applying for a mortgage. But does paying points make sense for VA loans? Let's dive deep into mortgage points, how they work with VA loans, and whether you should pay them on a VA mortgage.

With mortgage rates rising in 2023, many buyers are looking for ways to keep their monthly payments affordable. Paying points, also known as discount points, can effectively lower your interest rate and monthly mortgage payment. But issues come at an upfront cost, so you must determine if paying them will pay off in the long run.

What Are Mortgage Points, and How Do They Work?

Mortgage or discount points are fees you pay your lender upfront to reduce your mortgage interest rate. Each mortgage point typically costs 1% of your total loan amount and lowers your rate by 0.25%.

So if you purchased two discount points on a $300,000 loan, it would cost you $6,000 ($300,000 x 2% = $6,000). And your interest rate would decrease by around 0.5%.

On a 30-year fixed mortgage, paying points can save you thousands of dollars in interest over the life of the loan. The more points you pay, the lower your rate will be.

Do Points Make Sense for a VA Mortgage?

VA loans have very competitive interest rates, even without paying points. Rates are low because the Department of Veterans Affairs guarantees a portion of the loan amount, protecting the lender from default.

Since VA rates are already below the market average, some borrowers question whether paying points is worth it. The answer depends on your situation.

Paying 1-2 points can make sense if you keep the mortgage for several years. The interest savings from a lower rate generally offset the upfront cost over the long run.

But the points may not pay off if you only stay in the home for a few years. You also want to factor in closing costs. VA loans allow you to roll points into the loan amount, avoiding out-of-pocket expenses.

How Much Do Points Typically Cost on a VA Mortgage?

VA loans limit how many points you can pay to decrease your rate.

One point: VA allows you to pay up to 1 point in closing costs, which sellers often agree to cover. This will lower your rate by about 0.25%.
Two points: You can pay up to 2 discount points in total. So if the seller pays 1 point, you could spend 1 point to reduce your rate by around 0.5% further.
Four points: For VA Interest Rate Reduction Refinance Loans, you can pay up to 4 points to get the lowest possible rate.

Each point costs 1% of the mortgage amount. On a $300,000 loan, 1 point would equal $3,000, and 2 points would equal $6,000. The exact costs vary by lender.

How Do I Know If Paying Points on a VA Loan Is Worth It?

Determining if points are worth it requires some mortgage math and estimating how long you'll stay in the home. Here are some key factors to consider:

Interest rate reduction: calculate how much your rate will decrease per point paid. Often, only the first 1-2 points make a significant impact.
Upfront cost: know how much you'll pay in points and closing costs.
Breakeven timeline: Determine how long it will take for interest savings to offset the upfront cost. Often 5-7 years for 1 point.
Length of stay: estimate how long you'll keep the mortgage. Points rarely pay off if you sell in less than five years.
Plans: Consider if you may refinance or move again soon. This shortens the payoff timeline.

Doing the math can help determine if points fit your budget and plans. Online mortgage calculators can estimate your breakeven point.

Pros and Cons of Paying Points on a VA Mortgage

Before deciding if you should buy points, weigh the key pros and cons:

Pros

Lower interest rate and monthly payments
Pay less interest over the loan term.
Roll points into the loan amount if refinancing or included with a seller concession.
Interest paid on points is tax-deductible.

Cons

Points can be expensive (often 2%–4% of the loan).
Must stay at home long enough to recoup costs
There is less benefit if you have plans to move or refinance soon.

Scenarios When Paying Points Makes Sense

While points don't make sense for everyone, here are some common scenarios where paying 1-2 points can be advantageous:

You plan to keep the mortgage for at least 5-7 years.
You can afford the upfront costs, or the seller covers one point.
You want to lower your monthly mortgage payments.
A slight rate decrease would save thousands in interest.
You have an Interest Rate Reduction Refinance and can pay up to 4 points.

Paying points is most beneficial if you know you'll stay put for many years. You'll recoup the costs over time through interest savings.

How to Pay for VA Mortgage Points

One significant benefit of VA loans is that you can finance points within the loan amount, avoiding out-of-pocket costs. There are two main options:

1. Seller pays: Ask the seller to credit 1 point toward closing costs. This is common with VA loans.

2. Roll into the loan: You can finance up to 2 discount points into the loan amount with a refinance. This increases your principal but avoids upfront fees.

Either way, you don't have to pay thousands for points at closing. Just keep in mind that the issues will increase your loan balance.

Tips for Getting the Best VA Mortgage Rate

Beyond paying points, here are a few tips to score the lowest rate when you apply for a VA loan:

Shop lenders: compare mortgage rates from multiple lenders. Online lenders often have the lowest rates.
Get a pre-approval: Being pre-approved signals, you're a qualified buyer and can prompt lenders to offer their lowest rate.
Check published rates: Look at lenders' published VA mortgage rates reflecting discounted pricing.
Improve your credit. Good credit can lower your rate. Aim for a score of at least 740 before applying.
Lower your debt: the less debt you have compared to your income, the better rate you can qualify for.
Make a larger down payment. Down payments as low as 0% are allowed, but 5%–10% down can mean a lower rate.
Lock your rate. Time your rate lock to get the best price. Rates trend up heading into the summer home buying season.

Paying points can reduce your rate, but it's not your only option. Following these tips can help you land a competitive VA loan quote.

Frequently Asked Questions

Q: What are discount points?

A: Discount points are fees paid to a mortgage lender at closing to lower the interest rate on your loan. Each discount point typically costs 1% of the loan amount and can reduce the interest rate by about 0.25% to 0.375%.

Q: How do points work?

A: When you pay for discount points, you are essentially prepaying a portion of the interest on your loan. By doing so, you can lower your monthly mortgage payments and potentially save money over the life of the loan.

Q: Are points worth it?

A: Whether or not points are worth it depends on your financial situation. If you plan to stay home for a long time and can afford the upfront costs, paying for discount points can save you money in the long run. However, if you plan to sell your home or refinance it shortly, the upfront costs may not be worth it.

The Bottom Line: Should You Pay Points on a VA Mortgage?

While prevalent with conventional loans, paying discount points is less common with VA home loans. VA rates are already below the market average, even with zero issues.

But if you want the absolute lowest rate and can pay points cost-effectively through closing credits or rolled into your loan amount, 1-2 points may make sense.

Just be sure to do the math and determine if you'll stay in the home long enough to recoup the costs through interest savings. Purchase points conservatively and compare your total prices with lender quotes with no issues.

If you're on the fence about paying points on a VA loan, talk to a mortgage officer who can run the numbers and provide a clear recommendation based on your specific home purchase scenario, credit, down payment, and plans for the future.

SOURCE:
https://www.home.loans/VA-loans
https://www.forbes.com/advisor/mortgages/VA-loan-closing-costs/
https://www.upwellmortgage.com/VA-loans/