There aren’t very many ways you can make a loan cheaper than what is offered to you by the lender, so it’s best to use the few weapons you have to their highest effect. First, you have to know how the loan terms are calculated in the first place. Obviously, the loan amount is typically determined by the cost of the home. In the case of VA loans, the loan amount is determined by what the VA appraiser deems to be the reasonable sale price of the home, and that number is about as flexible as a brick, maybe a little less. There’s not much you can do about the loan amount, but the interest rate is a place where keeping your wits about you is a smart plan. As a borrower, when you’re looking to commit to paying off a VA mortgage for the next 30 years, the burden will fall upon you to negotiate the interest rate with the lender.
Now, there are certainly a number of things that prevent the most ideal interest rate from being within your grasp, some of which have nothing to do with the lender. Your credit score in a large way determines what interest rates you’ll be eligible for, and there’s not much good that negotiating will do. Your loan repayment history and even that day’s interest rate sheet play major roles in determining how much the lender will budge on the interest rate. So with all that in mind, what options are available to you? What tool can you pull out of your tool belt to help save you a few thousand dollars over the next 30 years? Two words: discount points. They certainly have a fantastic name; a name that reeks of money-saving implications and sounds very desirous. But what are discount points, and how do they work? How do you use them?
Short answer: you buy them. The VA Lender’s Handbook, also known to those in the know as VA Pamphlet 26-7, discusses discount points a bit. It explains that the borrower can pay for discount points, and that the borrower and lender agree on the amount, and may be based on the loan principal amount after the funding fee is added to it, if the funding fee is being financed. From the Handbook: “Veterans may pay reasonable discount points on VA-guaranteed loans
. The amount of discount points is whatever the borrower and lender agree upon. Discount points can be based on the principal amount of the loan after adding the VA funding fee, if the funding fee will be paid from loan proceeds.”
Discount points are fairly simple. Discount points generally cost 1% of the loan principal (so when the VA says they can be based on the principal after the funding fee is added on, that actually makes them more expensive for you), and drop the interest rate by between 1/8 of a percent and 1/4 of a percent, so it would take at least four discount points to lower an interest rate by a full percent (from 5% to 4%). Buying discount points in exchange for a lower interest rate can be a really good idea if you’re confident you’ll be paying the loan down through to the end instead of selling, because even 1/2 of a percentage point can make a huge difference over a 30-year period.
Discount points are usually paid out-of-pocket, because otherwise it doesn’t make a whole lot of sense for the lender (so…instead of getting $15,000 extra dollars over the next 15 years, you’re offering me $6,000 over the next 15 years…um, no, thanks.) But the VA does allow for discount points to be included in the loan amount in some circumstances. According to the VA, the loan has to be a type of refinance, and depending on the type of refinance, a certain amount of discount points can be rolled into the loan, and the rest needs to be paid out of pocket. From the VA: “Discount points may be rolled into the loan only in the case of refinancing loans, subject to the following limitations:
INTEREST RATE REDUCTION REFINANCING LOANS
A maximum of two discount points can be rolled into the loan.
If the borrower pays more than two points, the remainder must be paid in cash.
REFINANCING OF CONSTRUCTION LOANS, ETC.
Loans to refinance are:
• a construction loan,
• an installment land sales contract, or
• a loan assumed by the veteran at an interest rate higher than that for the proposed refinancing loan
Any reasonable amount of discount points may be rolled into the loan as long as the sum of the outstanding balance of the loan plus allowable closing costs and discount points does not exceed the VA reasonable value.”