You’ve just bought your dream home and now your finalizing your mortgage. Your lender ask if you want to purchase “points” on your mortgage and now you’re confused. Should you or shouldn’t you? What exactly are these points that your lender is talking about?
Mortgages come with “points” – a polite synonym for fees or premiums that your lender charges for loan origination or refinancing. The math on points is simple: one point equals 1% of the amount of the loan you take out, two points equal 2%, and so forth. While the math is easy, the real value of a point is not always so simply calculated.
There really is a point. Why would you want points? Well, when you buy a point or two along with your mortgage, you get a lower interest rate and a lower monthly payment. Pay $3,000 for a point now, and you could save that much and more later on over the course of the loan.
What’s the Point?
But it may seem pointless. The problem is, points don’t move when you do. Who stays in one home for 30 years these days? If you have a 30-year loan and you sell your home and move five years from now, you lose the points and the benefits that go with them. The same applies when you refinance. There’s also the interest rate aspect. Let’s say you buy two points at 6% interest when you get your mortgage. What if two years later, interest rates fall to 4%? You’ll regret your purchase.
Are There Tax Benefits?
Sometimes. Usually, points are amortized over the duration of your mortgage – that is, paid off in installment payments over the life of the loan. But you might be able to deduct the cost of these points at tax time.
If you took out your mortgage to buy or refinance your primary residence, you could qualify for a deduction in the tax year you took out the loan, if your loan meets certain conditions. The IRS has a 9-point test, and the key points are:
- the points must be a percentage of a principal amount clearly defined on the settlement statement
- the points can’t be paid in place of separately stated amounts elsewhere on the settlement statement
- funds supplied by the buyer + points paid by the seller must be equal to or greater than points charged
- points charged must not be excessive, and
- the charging of points must be “an established business practice” for such a mortgage. If you buy a home and the seller pays any points, you can deduct those points.
If you’re refinancing, there is no quick tax break. Points have to be amortized, unless you are using part of the loan for home improvement. Then a partial deduction is allowable.
If you’d like more information on mortgages and the financial questions linked to them, speak with a qualified mortgage professional today.
This was prepared by Peter Montoya, Inc., not the named Representative or Broker/Dealer, and should not be construed as investment advice. Neither the named Representative or Broker/Dealer give tax or legal advice.
Jeff Rose is an Illinois Certified Financial Planner and co-founder of Alliance Investment Planning Group. He is also the author of Good Financial Cents, a financial planning and investment blog. You can also learn more about Jeff at his website Jeff Rose Financial.