Filing Your Income Taxes
Certain expenses are tax deductible when you buy a home. The mortgage points you pay to a lender at closing to lower your monthly mortgage payments are one of them. You can deduct home mortgage points on your tax return in the year you pay them if you meet certain requirements. Otherwise, you can spread the cost of the points out over the life of the loan.
What Are Mortgage Points?
The interest you pay on a mortgage loan can hit the six-figure range over 30 years, a common loan term. But you can reduce your interest costs if you elect to pay mortgage points to your lender at closing. One point costs one percent of your mortgage amount, or $1,000 for every $100,000 you borrow. You'll pay $3,000 at closing if you take out a mortgage for $300,000.
Each point you buy can shave 0.25 percent off the interest rate you’ll pay, although the exact percentage can vary by lender. You could drop a 4.25 percent interest rate down to 4 percent by paying that $3,000 at closing.
The IRS and Mortgage Points
The cost of those points may be tax deductible because it counts as interest for tax purposes. The interest you pay each year on your home loan is tax deductible if you itemize, so you can deduct what you paid for home mortgage points according to some rules.
But there’s a cap on how much of a deduction you can claim. It used to be that you could deduct interest on loans of up to $1 million, but the Tax Cuts and Jobs Act reduced this threshold to $750,000 for mortgages taken out after Dec. 15, 2017. TCJA rules remain in place through 2025 when the TCJA potentially expires if Congress doesn't renew its terms.
You must itemize to claim a deduction for mortgage interest and points. This means tallying up all your itemized expenses for the tax year on Schedule A of your Form 1040 and submitting it with your tax return. You can't claim the standard deduction, too, if you itemize. You must itemize or use the standard deduction. You can't do both, so make sure the total of all your itemized deductions works out to more than the standard deduction you'd be entitled to for your filing status.
Read more: How to Calculate Mortgage Interest
Deducting Mortgage Points in Full
You have two options for deducting mortgage points. The first is to deduct the full amount in the year in which you paid them. The other is to deduct them over the life of the loan.
You must meet several requirements to deduct the full amount in the year you paid them:
- The loan must be secured by your primary home.
- The loan is used either to buy or build your primary home.
- Paying points is acceptable in the area where the mortgage was issued.
- The number of points paid was normal for the area where the mortgage was issued.
- You use the cash method of accounting. This means that you claim all your income and deductions in the year in which they were received or paid.
- The money you paid was used to pay down interest, not for other items such as fees and taxes.
- The funds you used to pay the points were not granted as a loan from your lender or mortgage broker.
- The lender must have calculated the points as a percentage of the principal amount of the mortgage.
- The points payment must be a line item on your settlement statement.
You'll have to divide the deduction equally over the life of the loan if you don’t meet all these requirements. For example, points and interest using a second home as collateral must be divided equally over the life of the loan.
Enter what you paid for points on line 8a or line 8c of the 2021 Schedule A that you'll file in 2022, depending on whether you received a Form 1098 from your lender. You can then transfer the total of all your itemized deductions, which appears on line 17, to line 12A of your Form 1040 or 1040-SR tax return.
Deducting Mortgage Points Over Time
You must divide the points you paid over the number of payments you’re scheduled to pay over the life of the loan if you don't qualify to pay them in the first year. That would be 360 monthly payments in the case of a 30-year loan: 12 payments a year times 30 years. You can deduct the 12 payments paid in the tax year for which you're filing the return.
You can deduct any remaining points when the loan is paid off if you sell the property or refinance the loan before you pay it off over multiple years.
Determining the Points Paid
Your lender should issue you a Form 1098 at tax time, telling you and the IRS the number of points you paid. This form will also include all the interest you paid on your mortgage with your loan payments during the tax year. You can find the number of points you paid on line 6.
Not all points will appear on this form, including those that were paid on a refinance or on a second home. You would use box 8c on Schedule A in this case.
Refinancing and Home Improvement Loans
You can also pay points to lower your interest rate if you’re refinancing or taking out a home improvement loan. You must meet the same qualifying rules as you would with a first mortgage. You must make sure your loan meets all criteria for you to deduct the points in the year you paid them. Otherwise, you’ll have to divide the points by the number of monthly payments and deduct that amount each year instead.
Homeowners often struggle with whether to pay points at closing. Experts refer to the “break-even point” when making this decision.
Should You Pay Points?
Homeowners often struggle with whether to pay points at closing. Experts suggest determining your “break-even point” when you’re making this decision. This is the point in time when the money you’ll save over the course of the loan equals the amount you paid upfront for points. The up-front payment will make it worth it if you exceed this break-even point. Don't neglect to calculate the money you'll save in taxes by claiming a deduction.
But it still might not be worth it even if you’ve run the calculation and you find that you’ll save money. You’ll have to come up with thousands of dollars at closing, in addition to your down payment at a time when you’re also paying closing costs. And the savings on an interest rate may not mean as much to you five years down the line when you’re potentially earning more.
- IRS: Schedule A Itemized Deductions
- IRS: Topic No. 504 Home Mortgage Points
- IRS: Frequently Asked Questions / Real Estate (Taxes, Mortgage Interest, Points, Other Property Expenses) 6
- IRS: Form 1098 Mortgage Interest Statement
- Consumer Financial Protection Bureau: What Are (Discount Points) and Lender Credits and How Do They Work?
- IRS: Publication 936 Home Mortgage Interest Deduction
- Tax Foundation: Reviewing How TCJA Impacted Mortgage Interest and State and Local Tax Deductions
Stephanie Faris has written about finance for entrepreneurs and marketing firms since 2013. She spent nearly a year as a ghostwriter for a credit card processing service and has ghostwritten about finance for numerous marketing firms and entrepreneurs. Her work has appeared on The Motley Fool, MoneyGeek, Ecommerce Insiders, GoBankingRates, and ThriveBy30.