Mortgage points are extra fees paid to a lender when you buy a home or refinance your existing mortgage. They’re also known as discount points, origination points, or simply “points.” Each point is equal to one percent of the total loan amount and can result in a lower interest rate on your mortgage. Paying these points can be a smart financial decision, especially if you plan to stay in your home for more than a few years. But there’s an important tax aspect to consider when you pay points on a mortgage: their impact on your taxes.
When it comes to the tax impact of mortgage points, the general rule is that you can deduct the full amount of any origination points paid in the year they were paid. However, prepaid interest (also known as discount points) must be deducted over the life of the loan. That means if you pay one point ($1,000) over the course of 30 years, you can deduct $33 per year ($1,000/30).
It’s important to note that not all mortgage points are deductible. The deduction is only available if you use the proceeds from your loan to purchase or improve your primary residence. If you use them for other purposes like paying off credit card debt or investing in stocks and bonds, then those points are nondeductible.
The good news is that if you itemize deductions on your tax return and meet certain criteria for deducting interest expenses, then any deductible mortgage points will be included as part of that deduction. That means if you have $2,000 in deductible mortgage points and $3,000 in total interest paid during the year, then only $3,000 will be deductible – not both items separately.
The bottom line is that paying mortgage points can have a significant impact on your taxes – but only if it meets certain criteria established by the IRS. If used properly and strategically it can save money and even reduce your overall tax burden – but only when used within certain limits set by law.
For example: let’s say you take out a 30-year fixed-rate loan at 4% with no origination fees or discount points paid upfront – this would equate to an annual interest expense of $1204 per month (for principal + interest). Now let’s say that instead of accepting this rate – you choose to pay two discount point upfront (2% of total loan amount), which reduces your rate down to 3%. This would result in an annual interest expense reduction of approximately $965 (for principal + interest). After taking into account the $2k cost associated with paying two discount point upfront – it would still result in an overall savings of roughly $3500 over 30 years!
This calculation illustrates how beneficial paying one or two point upfront could be for savvy homeowners who plan ahead for their future savings needs. And when done correctly and within IRS guidelines – these savings will not only help lower monthly payments but also reduce taxable income at tax time!
Remember though – no matter what option(s) you choose – always consult with an experienced professional who specializes in mortgages and taxes before making any final decisions regarding any decisions related to refinancing/purchasing a home!