What Are VA Loan Discount Points and Why Do They Matter?

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.

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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.”

Considering the Age of a Home for a VA Loan

VA loans are subject to a lot of confusion and misconceptions. Many of them surround the VA appraisal, which, unfortunately, does a great job at creating confusion. Most VA-approved lenders, however, are very good at explaining the VA appraisal, and often a borrower simply needs to ask in order to get their questions answered. One of the things that borrowers want to know in regards to the VA appraisal or VA loans in general, is whether there is an age limit on the homes they are allowed to buy. Does the home have to be built after a certain year in order for the VA to be willing to guarantee the loan? If so, what is that year? What are the VA standards in this area and are there exceptions to those standards?

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The short answer to whether the VA has established an age limit on homes is no. As with every short answer, however, there is a ‘but’, followed by a much longer answer. Nowhere in the VA lender’s guide or rule book does it specifically mention the age of the home. Regardless of age, however, the home does have to meet the VA’s minimum property requirements, as well as all state and local building codes, which many older homes may not. The requirement most directly associated with age, however, is the property’s “remaining economic life”. While a home’s remaining economic life declines over time (alas the nature of life), it does not necessarily mean that an old home has little remaining economic life, so even with this requirement, there is no real age limit that can
be put on a home. A home built 100 years ago that was built well and properly maintained and updated as time went on can still have enough remaining economic life to be approved for a VA loan.

The rules for remaining economic life, at least for a home to be approved by the VA, is very utilitarian in nature. The home must have an estimated economic life that is at least as long as the terms of the mortgage (so 15 or 30 years). Quick definition on economic life for those unfamiliar with the term: how long the home is considered ‘salable’. In other words, when the home is no longer salable on the real estate market, its economic life is considered over. Additionally, the estimate on the remaining economic life has to be supported and not the result of a shrug of the shoulders and “it looks fine to me”. Directly from VA Pamphlet 26-7: “For VA Loan Guaranty purposes, the remaining economic life of the security must be at least as long as the loan repayment term. A short remaining economic life estimate must be supportable and not arbitrarily established. This is to avoid depriving veterans of the home of their choice in an area where they can afford to live.”

Estimating the remaining economic life is the job of – you guessed it – the VA appraiser. The appraiser looks at a number of variables, including the relationship between the property and the area it is in (is this a drug war zone?). The appraiser also looks at other homes in the area in direct comparison to the one being appraised, the build of the home from a functionality perspective, and the workmanship of the home, as well as how well it’s been maintained and whether it’s been kept in good repair. As mentioned above, the actual age of the home can certainly be a factor; in fact, it can be a defining factor if over the age of the home it has not been taken good care of, but there is nothing specifically that prohibits a home from being a certain age. Directly from Pamphlet 26-7:

“In estimating remaining economic life, the appraiser must consider

  • the relationship between the property and the economic stability of the block, neighborhood, and community
  • comparisons with homes in the same or similar areas
  • the need for a home of the particular type being appraised
  • the architectural design, style, and utility from a functional point of view
  • the workmanship and durability of the construction, its physical condition and probable cost of maintenance and/or repair
  • the extent to which other homes in the area are kept in repair, and in areas where rehabilitation and code enforcement are operating or under consideration, their expected results in improving the neighborhood for residential use.”

 

Eligibility Requirements for VA Loans

Being eligible for a VA loan opens up a world of benefits and money-saving opportunities. VA loans allow an eligible borrower to open up a loan to buy a home with backing from the Department of Veteran’s Affairs (VA). This backed, or guaranteed, mortgage motivates the lender to provide a more favorable interest rate than the borrower would normally be eligible for based on their credit score. Eligibility is based on whether the person has served or is serving in the armed forces, including Guard and Reserve servicemembers.

For a full-time service member, you are eligible essentially from the moment you graduate from basic training. Technically, a servicemember is eligible from the moment basic training starts, but good luck trying to go through the steps and hoops necessary to get one during basic training. Quite frankly, if you’re thinking about a mortgage and the benefits of a VA-guaranteed mortgage vs. a conventional mortgage while you’re knee-deep in mud running up a mountain on 2 hours of sleep, there may be something wrong with you. If the recruit were to make such a request, however, they would likely be told to wait until basic training was completed to make the request.

Once basic training is completed, as a recruit goes through individualized technical training or AIT, if the recruit were to make a request about getting a VA mortgage, he or she would likely be told the same thing. In this case, however, it has more to do with the lack of time that the recruit would have to handle such a thing. Only after training has completed will the recruit have the necessary disposable time to properly work out a VA-guaranteed mortgage.  But at the conclusion of training, the active servicemember is immediately eligible for benefits and can begin the process whenever he or she sees fit. But something that ought to be remembered is that at the beginning of military service and for the first few years, the service member will typically be moved around with some frequency. That makes it rather difficult and not usually wise to open up a VA loan in the early years of service. But it is theoretically possible if desired.

For an active servicemember to start the process for getting a VA-backed mortgage, they’ll need to meet with a lender to acquire a Certificate of Eligibility (COE). Going through a lender is not the only way to get a COE, but it is usually the easiest. Once the COE is obtained, the rest of the process can be followed, using existing documents such as recent military pay stubs as evidence for a servicemember’s eligibility.

But for a guard or reservist, the process is a little bit more complex. Just as for regular service members, the VA loan benefits provide guard and reservists an opportunity to get a better interest rate than they would normally qualify for. However, for guard and reservists, there is a requirement for minimum time served in order to be eligible for those benefits. Those serving in the Guard or the Reserves have to complete at least six years of service before being eligible. This restriction is in place because of the smaller time commitment and looser separation policies of the guard and reserves compared to full-time service. By establishing a minimum service requirement, abuse of the system is prevented in a large way.

If a guard or reservist has retired, the minimum service requirement is not a concern because it has obviously been completed and all that is required to demonstrate eligibility is an NGB Form 22. The NGB Form 22 is a Report of Separation and Record of Service. There is another form that is allowable as evidence, called the NGB Form 23, or the Retirement Points Accounting. One of these forms in addition to proof of the nature of discharge should be sufficient to establish eligibility for a VA loan.

If a member of the Selected Reserve that was never discharged would like to utilize his VA loan eligibility, they will need to provide a copy of their most recent annual retirement points statement and evidence of honorable service. If they were activated, they merely need to provide their DD Form 214.

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*Annual savings calculator based on 2015 monthly average savings extrapolated year-to-date.