Some of the the most common questions asked by people when shopping for a home loan involve points: What are points? Should I pay them? How will they affect what I pay every month?
Simply put, a point, also called a discount point, is prepaid interest on the loan. A point is equivalent to a percentage of your loan amount – one point equals one percent. Paying for points is a way to lower the interest rate on your loan because the more points you pay for, the lower the interest rate you receive. However, it’s important to remember that this is interest you are paying for in advance and in some cases will be due at closing.
If you are refinancing your VA home loan, you may have the option to purchase your points in cash or to roll the payment into the loan amount. If you are buying a new home with a VA loan, you will have to pay for those points at closing.
Your lender, not the Department of Veterans Affairs, sets the interest rate, points and closing costs, and they may vary from lender to lender. As long as the borrower is paying “reasonable discount points on VA-guaranteed loans” in an amount that is “whatever the borrower and lender agree upon” as stated by the VA loan rules, it’s up to you and your lender to negotiate an appropriate amount for your situation.
Keep in mind, even though it initially sounds like a better deal to get a lower interest rate over the life of your loan – it’s not necessarily always right for all borrowers. Understanding your VA loan benefits is helpful when you’re buying or refinancing your home, but it’s equally as important to go with a lender who has your best interests in mind. Pick a lender that has a long history of experience in the mortgage industry, one that has a dedicated team that specializes in VA loans, and one that takes the time to explain every detail and find the best option for your financial situation.
One of the best ways to determine if you should buy points on your loan is to see how much you would save over the lifetime of the loan. For example: If you are looking to buy a new home with a 30-year fixed VA loan of $200,000 with a rate of 3.875% and 0 points, your monthly payment would be $1,467. However, if you get that same loan with a rate of 3.25% and 2 points, your monthly payment would be $1,406 – saving you $61 per month.
Your closing costs with 0 points would be $1,265 compared to 2 points and $5,265 in closing costs.
To find out if this makes sense to pay for points, divide your monthly savings into the points paid, and the answer is how many months it will take to recover the additional amounts paid into points. $61 into $4000 is just over 65 months, or nearly 5 ½ years.
Once you have this number, you can compare that savings with your budget. It’s important to consider what your goals are for your home – if you plan on staying in your home for the long term, a lower interest rate will save you thousands over the life of your loan. One other important factor to consider is that points may be tax deductible, so make sure you consult with a financial advisor or your Home Loan Expert to see how this may help you as well.
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