What Are Mortgage Points? Definition
To answer your question, “what are mortgage points?”, let’s start off with the names that are also used to describe points.
Mortgage points, otherwise known as “loan origination fees”, “loan processing fees”, “loan discount”, “discount points”, or “maximum loan charges” are normally incurred when you obtain a loan at a set interest rate.
The mortgage points increase the lender’s upfront fees but borrowers are generally charged a lower interest rate over the loan term.
So what are mortgage points? Basically, mortgage points are a form of prepaid interest to lower your overall interest rate.
Time wise, what are mortgage points deductible in? Mortgage Points are deductible in the year they are paid OR over the term of the loan. Points are based on a percentage of the loan, with each point being equal to 1% of the loan. Thus, if you obtain a $300,000 mortgage loan, one point is $3,000.
What Are Mortgage Points Requirements
You can fully deduct points in the year paid if you meet the following tests:
- 1. Your loan is secured by your main home (Your main home is the the one you ordinarily live in most of the time).
- 2. The charging of points is an established business practice in the geographic area in which the loan is made.
- 3. The points were not more than the points generally charged in that area.
- 4. You use the cash method of accounting. This means you report income in the year you receive it and deduct expenses in the year you pay them.
- 5. The points were not paid in place of amounts that ordinarily are stated separately on the settlement statement, such as appraisal fees, inspection fees, title fees, attorney fees, and property taxes.
- 6. The funds you provided at or before closing, plus any points the seller paid, were at least as much as the points charged.
- 7. You use your loan to buy or build your main home.
- 8. The points were computed as a percentage of the principal amount of the mortgage.
- 9. The amount is clearly shown on the settlement statement as points charged for the mortgage. The points may be shown as paid from either your funds or the seller’s.
Note: If you meet all of the tests listed above and you itemize your deductions in the year you get the loan, you can either deduct the full amount of mortgage points in the year paid or deduct them over the life of the loan, beginning in the year you get the loan. If you do not itemize your deductions in the year you get the loan, you can spread the points over the life of the loan and deduct the appropriate amount in each future year, if any, when you itemize your deductions.
What are Mortgage Points – General Rule for Deducting Mortgage Points
Points are either treated as a type of prepaid interest or as a nondeductible service fee, depending on what the charge covers. If the points qualify as interest, they are deductible over the term of the loan unless they are paid on the purchase or improvement of your principal residence, in which case they are deductible in the year that they are paid.
Home Improvement Loan
You can fully deduct in the year paid points paid on a loan to improve your main home if you meet the first six tests listed above.
If you pay points on a mortgage secured by a second home or a vacation home, the points are not fully deductible in the year of payment. You can deduct these points only over the life of the loan.
Mortgage Points Paid by Seller of Property
Points paid by the seller are deductible by both the buyer and the seller. When the seller pays points on the sale of a principal residence, the buyer may deduct those points as interest, but both must subtract these points from the purchase price of the residence.
What Are Mortgage Points on a Refinanced Mortgage
Points you pay to refinance a mortgage are not deductible in full in the year you pay them. This is true even if the new mortgage is secured by your principal residence. According to the IRS, points paid to refinance an existing home mortgage are for repaying the taxpayer’s existing “indebtedness” and they are not paid “in connection with” the purchase or improvement of the home. Therefore, taxpayers must deduct refinance points over the loan period.
The IRS requires taxpayers to deduct these points monthly over the term of the loan. For example, if you pay points of $3,600 when refinancing a 30 year loan on your principal residence, the IRS allows you to deduct only $10 a month, or $120 each full year.
However, if part of the refinanced mortgage proceeds were used to improve your main home and you can meet the first 6 tests above, you can fully deduct the part of the points related to the improvement in the year you paid them with your own funds. You can deduct the rest of the points over the life of the loan.
What Are Mortgage Points – Are Amounts Charged for Services Deductible?
Amounts charged by the lender for specific services connected to the loan are not interest. Examples of these charges are:
- Appraisal fees
- Notary fees
- Preparation costs for the mortgage note or deed of trust
- Mortgage insurance premiums
- VA funding fees
You cannot deduct these amounts as mortgage points either in the year paid or over the life of the mortgage.
What Are Mortgage Points That End Early
If you are deducting mortgage points on a refinanced loan and the mortgage ends early because you prepay the loan, the lender forecloses, or you refinance the loan again with a different lender, you can deduct the remaining mortgage points in the year the mortgage ends.
A mortgage may end early due to a prepayment, refinancing, foreclosure, or similar event.
Be sure to watch the video below which answers “What are Mortgage Points?”
Now you know the answer to “what are mortgage points?”. Next is if you should pay points or increase your down payment. Use this helpful calculator to determine the answer to that question.