Suppose you're buying a home and searching for a mortgage. There are a myriad of choices in today's marketplace with interest rates at near-record lows. In some cases, you may qualify for a rock-bottom rate if you agree to pay the lender "points" for the privilege. Sometimes these "points" are referred to as an origination fee.
Each point is equal to one percent of the amount you're borrowing. For instance, if a lender charges two points on a $200,000 loan, it costs you $4,000. The extra expense might be worthwhile to obtain a lower interest rate that can save you much more while you own the home. However, you need to understand the tax consequences to know if paying for points will work in your favor.
Usually, you can deduct the full amount of points as mortgage interest on your tax return, defraying the actual out-of-pocket cost. To qualify, however, you must meet certain requirements spelled out by the IRS. For instance, the loan must be secured by your principal residence, and imposing points must be an established mortgage business practice in the area where you reside.
What happens if you refinance an existing mortgage? It gets a little trickier. Generally, you're required to deduct the points over the life of the new loan. Let's say that you're replacing a 30-year mortgage with a 10-year loan with a lower rate. The loan principal is $200,000 and you're required to pay one point — $2,000. Based on these facts, you can deduct $200 each year for the next ten years. If you refinance again in the future, you can then deduct the balance of the points remaining from the first refinancing and start anew deducting points over the life of this second refinancing.
The rules are similar to a refinancing if you pay points on a mortgage for a second home. You must deduct the points over the life of the loan.
Before agreeing to pay points, crunch all the numbers, including taxes and deductions for points. Call if you need help.
