Up Next at Auction: Make a Winning Bid Using Mortgage Interest Points
from Carr, Riggs & Ingram
When a lender offers the next item up for bid – a brand spanking new mortgage! – a working knowledge of mortgage interest points can help a borrower come in with the strongest bid.
Going once: Understanding mortgage interest points
Mortgage interest points are payments made by a borrower to the lender when securing a home mortgage. They are sometimes known as discount points because they represent money paid to the lender in exchange for receiving a lower interest rate. In other words, these points are a way to “buy down the rate.”
It is common practice for each mortgage interest point to cost 1% of the total mortgage. In exchange, the lender reduces the interest rate by a certain percentage, often .125% or .25%. These specific values will vary based on lender, location, and terms of the loan.
On a 30-year, $250,000 mortgage, it would cost $2,500 (one point) to reduce the interest rate from 4.125% to 4.000%.
Interest points are typically paid by the buyer, but not always. When the seller pays points, the benefits nonetheless go to the purchaser, who will receive the lower interest rate and the tax benefits. Generally, sellers only pay points when they have a difficult time selling their home and need extra incentive to complete the sale.
Going twice: When to include mortgage interest points in a bid
By paying mortgage interest points, the buyer will have a reduced interest rate, resulting in a lower monthly payment. Mortgage interest points can be a great option when home buyers have money upfront that they can pay in exchange for paying less over the life of the loan. There is, however, a breakeven point, which will depend on the terms of the loan.
On a 30-year, $250,000 mortgage where one point paid down the rate by .125%, it would take 138 months (11.5 years) to break even.
Mortgage interest points can be great options for homebuyers who plan to stay in their homes for a long time. However, because the median tenure for a mortgage has historically been about six years in the United States, paying mortgage points is not the right choice for all purchasers.
Going three times: Tax benefits of mortgage interest points
Mortgage interest points are deductible in the year they are paid when they meet certain criteria, including the following:
- They are separately stated on the settlement statement,
- They are common practice in the area of purchase,
- The amount was paid in cash, rather than financed,
- They were paid in connection with the original purchase of a taxpayer’s primary residence, and
- The loan is secured by that home.
Keep in mind that refinancing a mortgage isn’t considered an “original purchase” and therefore points on the refi are not deductible in the year paid. Fortunately for the buyer, even if interest points do not meet the necessary criteria to be deducted in the year paid, the buyer can take the mortgage interest points deduction evenly over the life of the loan.
On a 30-year mortgage where the buyer purchased $3,000 worth of mortgage interest points, the buyer could deduct $100 each year for the next 30 years.
Deductions for mortgage interest points, as with other deductions for individual taxpayers, may be limited based on a taxpayer’s income, so discuss mortgage points with your tax professional before making a decision.
With the right preparation and knowledge, home buyers can offer the most appealing bids to their mortgage lenders and possibly get the chance to save money over the life of their loans. If you are considering purchasing a home or refinancing your existing mortgage, contact CRI’s tax professionals before you place your bid.