In this article, we will be discussing the how interest rates are calculated for VA loans and how VA policies surrounding discount points. Previously in Chapter 3 we talked in depth about the occupancy requirement and how it can be satisfied, as well as the maximum loan amounts a borrower can get a VA loan. We also gave a brief overview of the basic elements of a VA loan. All the information in these articles is taken directly out of the VA lender’s handbook to ensure that it is 100% accurate and to give you a comprehensive picture of the VA loan program, the benefits it offers you, and the requirements it has for you to participate.
In the past, the VA prescribed the interest rate for VA loans. They no longer do. Instead, the interest rate is negotiated between the borrower and the lender. The VA has found that this method allows the borrower and lender to agree on a generally more favorable interest rate than the VA would set in the past. The VA has also found that more lenders are willing to offer VA loans when they have the flexibility to set different interest rates. Once the rate has been locked-in, the borrower and lender are expected to honor it and any other agreements they have entered into which affect the interest rate. The interest rate can still be changed after that point, as long as it does not violate any existing lender/borrower agreements. The VA does have a process that needs to be followed for the interest rate to change, however.
If the increase is more than one percent, the loan needs to be re-underwritten to make sure the veteran still qualifies for the loan, the change must be documented, and a new (or corrected) Uniform Residential Loan Application (URLA), must be furnished. The borrower must initial and date next to any changes. Veterans can also pay for discount points on their interest rate. The Handbook specifies that veterans may only pay “reasonable” discount points on the loan. The borrower and lender agree upon a certain amount of discount points, and can be based on the principal of the loan before or after adding the VA funding fee, if the funding fee is being rolled into the loan amount.
Typically, discount points need to be paid upfront and cannot be included in the loan amount. The exception to this rule is for some refinances. For an Interest Rate Reduction Refinance Loan (IRRRL), two discount points can be rolled into the loan. No more than two can be rolled in, so if the borrower buys more than two, the remainder must be paid upfront. For refinancing a construction loan, installment land sales contract, or a loan assumed by an eligible veteran at a higher interest rate that what is being refinanced for, any “reasonable” amount of discount points may be rolled into the loan. The stipulation here is that the total loan amount, including discount points and allowable closing costs cannot exceed the VA’s determined reasonable value of the home. For cash-out refinancing loans, it’s all semantics – technically discount points cannot be included in the loan amount, but the cash can be given to the lender for any purpose that the lender finds acceptable, which includes paying discount points.
Once an agreement has been made concerning the discount points, both the lender and borrower are expected to honor the agreement. Any agreement that affects the discount points must not be violated. Changes can still be made to agreed-upon discount points, as long as all is in accordance with the agreements that the lender and borrower have signed relating to discount points. An increase in discount points requires verification that the borrower has sufficient assets to cover the increase, documentation of the change, and a new URLA that has the changes properly initialed and dated by the borrower.
A quick word on discount points. Discount points are a way of paying cash to get a lower interest rate. A “point” is usually something like .125% and may cost 1% of the loan amount. So for a $200,000 home and an interest rate of 4.50%, a discount point could cost $2,000 and drop the interest rate to 4.375%. This may not seem like much, but it adds up significantly over 30 years. Points can also knock as much as .25% off the interest rate, and could cost more or less than 1% of the loan amount.