One of the ways that you can reduce the interest rate on your home mortgage loan is to pay points. A point is equal to 1% of the cost of your loan principal. If you get a mortgage for $180,000, each point is $1,800. You can usually get a reduction in your interest rate by up to 1/4 of a percent. (Some lenders will not offer such a discount, though.) So if you pay two points on a mortgage loan with an interest rate of 5%, you could end up with a rate of 4.5%. If you will be in your home for a relatively long period of time, this could mean a savings of thousands of dollars over the life of the mortgage. And if you meet certain requirements, you can save on your taxes, since mortgage points are usually tax deductible.
Deducting Mortgage Points for Your Home Purchase
In order to deduct your mortgage points, you need to itemize your deductions on Schedule A of Form 1040. Your mortgage points paid are considered prepaid interest, and can be deducted as home loan interest. However, you do have to meet certain qualifications, according to the IRS:
- Your main home secures your home. You can buy or build your home, paying points on the loan.
- The payment of points is an established practice in your local market, and your points paid do not exceed the amount usually paid in your area.
- Your points were not used to go toward additional fees, such as appraisal fees, property taxes, title fees and attorney fees. The points should only be related to interest.
- What you provided for closing, and what the seller offered in points at closing, should be at least the amount of points charged. You cannot borrow money from your mortgage lender in order to pay the points.
- On your taxes, you use the cash method of accounting. This method of accounting means that you report income and deduct expenses in the year that they take place.
In order to deduct your mortgage points, the amount will also have to show as points on your settlement statement. If you meet the above requirements, you will likely be able to deduct all of the points you paid — as long as you are able to deduct all of the interest you pay on your mortgage in a year. It is important to note that if your home equity debt, or if your acquisition debt, exceeds $1,000,000, you will not be able to deduct all of your mortgage interest, nor will you be able to deduct the full amount of your points. However, you can deduct a portion of the points you paid. There is a table offered by the IRS to help you figure out how much you can deduct in those cases.
It is worth noting that a seller can pay points on your behalf and you get the tax deduction if you are buying. You will have to subtract the points paid by the seller from the cost of the home. Sellers can’t deduct these points as interest, but they do count as costs that can reduce the amount of the gain realized from the home.
If you do not meet all of the requirements for fully deductible mortgage points in one year, there might be a way to deduct your points over the life of the loan. Realize, too, that if your mortgage is on your second home, you will have to deduct mortgage points paid over the life of the loan.
Deducting Refinancing Points
You can also pay mortgage points when you refinance your home. It is important to note, though, that most of the time you have to deduct your points over the life of the loan. You can get a little boost if you are doing home improvements, though. If you meet the requirements in the bullet points above, and if you are using the money to improve your home, you can deduct points related to the home improvement fully, in the year you paid them — provided you used your own funds. As always, points that are applied to additional costs cannot be deducted.
Disclaimer: I am not a tax professional. Be sure to get professional advice before taking an tax deduction.