Are Home Mortgage Points Tax Deductible?

Mortgage points are a form of prepaid interest that can be used to reduce the interest rate on a mortgage. They are generally 1% of the total loan amount and can be paid either at closing or over the life of the loan. While mortgage points are not deductible in every situation, there are some instances where they can be written off on your taxes. Here's what you need to know about deducting mortgage points.

What Is a Mortgage Point?

A mortgage point is a fee charged by the lender at closing. Mortgage points vary in amount. If one mortgage point equals 1% of the loan amount and you borrowed $200,000, one mortgage point would cost you $2,000. Mortgage points are sometimes called discount points or origination points.

You can pay mortgage points to lower your interest rate, which also makes your monthly payments lower. You can also use mortgage points to buy down your interest rate during the life of your loan, which could save you money over time.

Types of Mortgage Points

The most common type of mortgage point is the discount point. Discount points are paid upfront to lower your interest rate. One mortgage point typically lowers your interest rate by 0.25%. So, if your interest rate is 4%, paying one mortgage point could lower it to 3.75%.

The second type of mortgage point is the origination point. Origination points are also paid upfront, but they don't lower your interest rate. Instead, they compensate the lender for processing your loan. You usually have to pay between one and three origination points, depending on the size of your loan and the lender's policies.

Some lenders offer a no-points mortgage, which means you won't have to pay any mortgage points at closing. You'll likely have a higher interest rate in exchange for not paying mortgage points.

To Deduct Mortgage Points, You Must Meet Three Conditions:

The mortgage is for the main home or second home that qualifies as a residence

A second home can qualify as a residence if it meets certain criteria set forth by lenders. In order for a second home to qualify as a residence, it must be located in a different geographic area than the borrower's main home.

Additionally, the borrower must demonstrate that they intend to use the second home as their primary residence for at least part of the year. Lenders typically require borrowers to take out a mortgage on their second home in order to qualify it as a residence.

Mortgage requirements for second homes are generally stricter than those for primary residences, so borrowers should expect to make a larger down payment and pay a higher interest rate on their second home mortgage.

However, borrowers who meet these stricter requirements may be rewarded with additional tax benefits: Interest paid on a second home mortgage is tax-deductible, and property taxes paid on a second home are also deductible. These benefits help offset some of the costs of owning a second home.

You use the cash method of accounting

The cash method of accounting is the most common way for individuals and businesses to keep track of their income and expenses. Under this method, income is only recorded when it is actually received, and expenses are only recorded when they are actually paid.

This contrasts with the accrual method of accounting, which records income and expenses when they are earned or incurred, regardless of when the actual cash changes hands.

The cash method is simpler and easier to understand than the accrual method, and it provides a more accurate picture of an individual or business's current financial position. However, it can also lead to some timing differences between reported income and expenses.

For example, if a mortgage point is paid upfront, the mortgage interest expense will be reported in the year the mortgage is paid off, even though the interest was incurred in previous years. Similarly, prepaid expenses will be reported as an expense in the year they are paid, even though they may actually be used to cover costs in future years. Overall, the cash method of accounting is a straightforward way to keep track of financial transactions.

You pay the points in cash rather than financing them through the loan

Paying mortgage points in cash saves you money over the life of your loan. That's because the interest you pay on your mortgage is based on the loan's principal balance.

The lower the principal balance, the less interest you pay over time. Therefore, paying mortgage points upfront helps you reduce the amount of interest you pay over the life of your loan.

If you finance your mortgage points through your loan, you'll be paying interest on those points for as long as you have the loan. In order to make financing mortgage points worth your while, you would need to stay in your home for a long enough period of time to offset the cost of those points with the interest savings. Otherwise, it's generally better to pay mortgage points in cash.

When You Meet the Three Conditions - 

If you meet all three of these conditions, you can deduct the entire amount of the points in the year that you paid them. For example, if you paid $1,000 in points on a $100,000 mortgage, you can deduct $1,000 from your income.

If you don't meet all three of the conditions above, you may still be able to deduct a portion of your points. In this case, the deduction is spread out over the life of the loan. So, if you paid $1,000 in points on a 30-year mortgage, you could deduct $33 per year for 30 years.

Conclusion

The bottom line is that deductible mortgage points can save you money at tax time. Be sure to keep good records of your mortgage payments so you can take advantage of this deduction.

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* Specific loan program availability and requirements may vary. Please get in touch with the mortgage advisor for more information.