Qualified homeowners can refinance their VA IRRRL with very little requirements. You don’t need a specific amount of equity or even a specific credit score. As long as there is a benefit to refinancing and you made your payments on time for the last 12 months you may qualify.
When should you pay discount points for a lower rate, though? Does it ever make sense to add this expense on top of the other closing costs?
What are Discount Points?
First, let’s look at the definition of discount points. They are a percentage of the loan amount that you pay. One point equals one percent of the loan amount. The lender looks at the money as prepaid interest. They will generally lower your interest rate 0.25%. If you pay two points, you may lower your rate 0.5% and so on.
The lender is able to lower your rate because they make the money up front. If they didn’t charge the points up front, they would not give the lower rate because they need to make money somewhere. Paying the points basically means you prepay the interest on the loan.
When Do Discount Points Make Sense?
The point of the VA IRRRL is to make your payment more affordable. Wouldn’t it make sense to pay the discount points and get the lower rate? It’s not always the case. You have to look at your situation.
First, figure out your recapture period. In other words, how many months of savings would it take to make up for paying the points?
Here’s an example:
You pay $2,000 for one point on a $200,000 loan. Without the point, you would get a 5.0% rate. With the point, you could get a 4.875% rate. The payments are as follows:
- 0% rate = $1,074
- 875% rate = $1,058
You would save $16 per month. Since the lower rate cost you $2,000, you’d figure out your recapture point as follows:
$2,000/$16 = 125 months
In other words, it would take you more than 10 years to pay off the point you paid. In this case, it’s probably not worth it. Generally, unless you can recapture the cost of the discount points in 3 years or less, it doesn’t make sense to pay for the lower rate.
Let’s look at another example. On the same $200,000 loan, let’s say you pay 2 points and receive a 4.5% rate rather than the 5%. Your payments would be as follows:
- 0% rate = $1,074
- 25% rate = $984
You’d save $90 per month with the lower rate. It would take you a little longer than 3 years to repay the cost of the points. In this case, you’d start benefiting after 4 years. If you know you will be in the home that long, it makes sense to pay the points.
How Long Will you Be in the Home?
The bigger question you need to ask yourself is how long you will be in your home. The typical homeowner moves every 7 years. Of course, you have your own circumstances. You may stay for less or more time, depending on your plans.
You should take your plans into consideration, though. If you think you may move before the recapture period ends, it doesn’t make sense to pay the extra money up front. You’ll pay a slightly higher interest rate, but since you’ll move before the recapture period would end, you come out ahead.
If you don’t think you’ll move in the near future, it may pay to take the discount points and pay the interest up front. After your recapture period ends, you pay less interest. You can look at the full cost of the loan over the entire term to see just how much money you would save over the life of the loan.
Paying discount points is a personal decision. You need to determine your future plans as well as how much you can afford to pay upfront. It doesn’t make sense to make yourself broke to save even $20 a month. But, if you can afford the point and it will save you a great deal of interest over the term of the loan, it may make sense.