Mortgage Points – Is it worth paying and are there tax benefits?
Whether you’re buying a home with mortgage or refinancing, paying mortgage points can help you get a lower rate and save in interest. And if the points are tax deductible, then you’ll save some more dollars as well. However, points may also constitute a part of the costs of making the loan.
What are mortgage points?
Mortgage points may be a kind of prepaid interest, or the costs of originating the loan. Each point is equal to 1% of the loan amount. There are 2 types of points as given below:
Origination Points: This is what the lenders charge as part of the costs of originating the loan. Depending upon the lender or mortgage company, the origination points are negotiable.
Discount Points: Such points are a kind of prepaid interest on your loan. The more points you pay, the lower will be the interest rate on your loan. Each discount point paid reduces your mortgage rate by 0.25% if it’s a fixed rate loan. For an adjustable rate loan, the rate will be reduced by 0.375%.
Is paying points worth it?
Whether you’ll pay mortgage points or more precisely discount points depends upon a number of factors as given below:
Length of your stay in the house: How long you’ll stay in the house determines your savings by paying points. The more the length of time that you live in the house, the more you will save through mortgage discount points. Use the mortgage calculator– “Calculate money saved by paying points” to find out how much you’ll save if you pay points.
Check your affordability: It’s for you to find out if you have enough cash to pay discount points upfront. After all, if you’re taking a purchase mortgage, you’ll have to pay the down payment also. And there are lenders who’ll charge prepayment penalty if you refinance your existing loan.
Are mortgage points tax-deductible?
Origination points are not tax-deductible. However discount points are deductible but you need to itemize your deductions whether you purchase a home or refinance.
For home purchase:
The points are deductible in the year you made the purchase. The criteria for deduction are:
The loan should be used to buy, build or improve your primary residence.
The points shouldn’t cover items (such as appraisal fees, title fees, property taxes etc) that are separately stated on the settlement sheet.
The points should be calculated as percentage of the principal loan amount.
What you paid at or before closing including the seller paid points should be at least as much as the points charged.
Mortgage points paid for a refinance are deducted over the life of the new loan. But if a part of the refinanced loan is used to improve your home and if you fulfill the criteria as given above for home purchase, then you can deduct that part of points in the year you paid them.
Apart from points paid during purchase and refinance, seller paid points are also deductible but only when the buyer extracts the amount from the cost of his residence.
No doubt, points are helpful in the sense that you can save a lot of interest and get tax benefits. But paying mortgage points makes sense only when you stay in the house for a longer period of time.
Guest Contribution Jenny Jones Debt Consolidation email@example.com
Our system of financing in Canada is structured differently, however I have had many clients ask about paying points on mortgages and thought an explanation worth posting as we keep seeing references in the media.