Filing Your Income Taxes
When you buy a home, certain expenses can be tax-deductible. One of those expenses relates to the mortgage points you pay to the lender at closing to lower your monthly mortgage payments. You can deduct home mortgage points on your taxes, but you’ll need to meet requirements to be able to deduct the funds in the year you paid them, rather than spreading the deduction over the life of the loan.
What Are Mortgage Points?
A home loan is a big commitment, paid over the course of many months. In fact, over the course of a 30-year loan, interest will be in the six-figure range, assuming you purchased a median-priced house at current rates. You can reduce the interest you pay with a large down payment or by refinancing or paying off your loan early.
Another way to lower the mortgage interest you’ll owe is to pay mortgage points at closing. One point costs one percent of your mortgage amount, or $1,000 for every $100,000. So if you’re taking out a mortgage for $300,000, you would need to pay $3,000 at closing.
Usually, each point you buy shaves 0.25 percent off the interest rate you’ll pay. So by paying that $3,000 at closing, you’d drop a 4.25 percent interest rate down to 4 percent. You can pay another $3,000 to drop it down to 3.75 percent and so on. But the exact amount that each point reduces can vary from one lender to the next.
The IRS and Mortgage Points
As you’re calculating whether buying down points is worth it, keep in mind that part of the payment may be tax-deductible. For tax purposes, that money you paid at closing to reduce the interest you pay counts as interest. If you qualify to deduct the interest you pay each year on your house, you should qualify to deduct what you paid for home mortgage points.
As with deducting interest, though, there’s a cap on how much you can claim. If the amount you spent on points and interest exceeds the limit for your filing status, you won’t be able to deduct the full amount. You’ll need to claim the deduction on Schedule A of Form 1040.
Read More: How to Calculate Mortgage Interest
Deducting Mortgage Points in Full
There are 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. In order to claim the full amount, you’ll need to meet all of these requirements:
- The loan is secured by your primary home. Points and interest using a second home as collateral must be divided equally over the life of the loan for tax deduction purposes.
- 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.
- Your accounting practices use the cash method. The cash method of accounting has you claiming all your income and deductions in the year in which they happened.
- The money was used to pay down interest, not for other items like fees and taxes.
- The funds used to pay the points down 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.
Deducting Mortgage Points Equally
If you don’t meet all of the above qualifications, you’ll need to divide the deduction equally over the life of the loan. You’ll see this as Line 8 on Form 1040, which is the form you use to claim itemized deductions. You’ll need to divide the points you paid over the number of payments you’re scheduled to pay over the life of the loan. In the case of a 30-year loan, that would be 360 monthly payments.
In many cases, a homeowner won’t remain in the home, paying on the same mortgage, for the entire 30-year life of the loan. When the time comes that the loan is paid off for whatever reason, you can then deduct the remaining points.
Determining the Points Paid
You don’t have to guess at the number of points you paid. At tax time, your lender will issue Form 1098. This form will include all the interest you paid on your mortgage in the tax year and you’ll see, on Line 6, the number of points you paid on your principal residence.
In some cases, not all points will be listed on that form, so make sure you scrutinize it carefully. If the points were paid on a refinance or second home, for instance, they won’t be listed there. Deductible points that aren’t listed on Form 1098 should be included on Schedule A, Line C, which reads “Points not reported to you on Form 1098.”
Refinancing and Home Improvement Loans
Your initial mortgage isn’t the only opportunity you’ll have to pay points and lower your interest rate. You can also pay points to lower your interest rate if you’re looking to refinance or take out a home improvement loan.
If you’re taking out a loan to do an improvement on your home, you’ll need to put it through the same test as a mortgage would for tax purposes. You’ll need to make sure your loan meets all criteria for you to deduct the points in the year you paid them. If not, you’ll have to divide the points by the number of monthly payments and deduct that amount each year.
Homeowners often struggle with whether to pay points or not during closing. Experts refer to the “break-even point” when you’re making this decision.
Should You Pay Points?
Homeowners often struggle with whether to pay points or not during closing. Experts refer to the “break-even point” when you’re making this decision. The break-even point is the point at which the amount you’ll save over the course of the loan equals the amount you paid upfront. If you exceed the break-even point, the up-front payment will make it worth it.
But even if you’ve run the calculation and found that you’ll save money by paying down points, it may not be worth it. You’ll have to come up with thousands of dollars in addition to your down payment at a time when you’re taking on a monthly mortgage. That savings on an interest rate may not mean as much to you five years down the line, when you’re potentially earning more money and you’ve recovered from the hefty down payment.
Read More: How to Pay Down a Mortgage or Save for a Dream Home
If you want to pay points on your mortgage for a lower interest rate, it can help to know how much you can deduct at tax time. This will help you truly calculate your savings. A big tax deduction in the first year you live in a new home could provide some relief, but if the cost of paying the points down puts you in a bind, it may not be worth it.
- The Simple Dollar: Here’s How Much the Average American Pays in Interest Each Year
- Better Money Habits: What Are Mortgage Points?
- IRS.gov: Schedule A (Form 1040 or 1040-SR)
- IRS.gov: Topic No. 504 Home Mortgage Points
- IRS.gov: Real Estate (Taxes, Mortgage Interest, Points, Other Property Expenses) 6
- IRS.gov: 2021 Form 1098
- This Old House: Here's How to Finance Your Remodel
- NerdWallet: Mortgage Points: Should You Pay These Optional Fees?
- Internal Revenue Service. "Topic No. 504 Home Mortgage Points." Accessed Nov. 3, 2020.
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.