There are two kinds of mortgage points that are common to loan offers and concern borrowers:
- Lender-charged loan origination points.
- Interest discount points.
Borrowers will find a wide choice in options when it comes to mortgage discount points if they want to pay up-front for a lower long-term interest rate on the loan. They should intend to remain in the home long enough for their lowered monthly payments to offset the up-front costs of the mortgage.
As for the other kind of points, a "loan origination fee" is based on a point schedule. It may be broken down as a point or two for the application fees, loan costs and commission. The lender may also pass on charges for points it grants to a broker in the sale.
In tallying the points, lenders and borrowers enter into a competitive conversation. The easiest way to regard mortgage points is that each point equals one percent of the total mortgage amount.
For example, if a loan is for $200,000, one point is worth $2,000. Today, a discount point roughly equates to a 0.25 percent interest rate reduction, but as the consumer buys points, the benefit doesn't automatically match up with a proportional ratio of discounts. It's about negotiation with the lender, who will let knowers their cost per each 0.5 percent drop in interest and the total points they may buy upfront.
Is it Worth Paying Down Mortgage Points?
The variables in determining the ultimate financial impact on paying for mortgage points can baffle most any borrower. It can seem like ordering off a menu in a foreign language. Simplifying everything, consumers are typically presented with rate/point options when they receive loan offers.
Choosing an option really comes down to the borrower's immediate needs and long-term financial outlook – and how to get the most out of the mortgage deal. A key determinant is how long the buyer or owner seeking a refinancing loan intends to live in the house. It takes time, even at a reduced interest rate, to recoup the heavy front-end cost of buying down the rate. Use LendingTree's Refinance Break-even Calculator to determine how long it will take to recover the up-front costs based on the reduced interest rate in a loan offer. The calculator allows users to enter the length of time they plan on residing in the house to help customize results.
Claiming Tax Deductions on Pre-paid Interest
Owners can claim paid-point tax deductions on their primary homes during the year the loan closes, claiming it all at once (as well as claiming applicable interest deductions on yearly tax returns over the life of the mortgage). Lenders are required to mail out a Mortgage Interest Statement (IRS Form 1098) indicating how much the owner paid on interest each year. Taxpayers include the amount on Schedule A of the 1040 long form.
Tax deductions on pre-paid interest are also allowed on a second home if the dwelling is not used as an investment property. Total amounts are capped: homeowners with acquisition debts exceeding $1 million or home equity debts surpassing $100,000 are not eligible to claim interest-payment deductions. Borrowers are encouraged to read the straightforward federal regulations on how the IRS treats mortgage point deductions online.
Before making any decisions based on tax benefits, be sure to contact a qualified financial advisor.