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Refinancing Mortgage Points & Deductions

Refinancing Mortgage Points & Deductions

Buying a home is one of the most expensive purchases most of us will make, so anything that can lower a mortgage cost is worth considering.

In addition to negotiating a good price and researching the best mortgage rates, some savvy buyers buy mortgage points, usually called "discount points," to reduce the amount of interest they pay.


What are mortgage points?

Mortgage points are fees that a buyer pays to a mortgage lender to reduce the loan's interest rate. This is sometimes called a "rate cut." Each point purchased by the borrower costs 1% of the value of the mortgage. Therefore, a point on a mortgage of $ 300,000 would cost $ 3,000.

Each point typically reduces the rate by 0.25%, so one point would reduce the mortgage rate by 4-3.75% over the loan's life.

Homebuyers can purchase more than one point and even fractional points. Half a point on a $ 300,000 mortgage, for example, would cost $ 1,500 and lower the mortgage rate by about 0.125%.

How much each point reduces the rate varies among creditors. The power to reduce the mortgage rate also depends on the type of mortgage loan and the general interest rate environment. Discount points are paid at closing and are listed in the loan appraisal document, which borrowers receive after applying for a mortgage. In the closing information, which loans receive before the loan closes.


Example of how mortgage points can reduce interest costs

If you can buy discount points, in addition to the entry and closing costs, you will lower your monthly mortgage payments and save a lot of money.

The key is to stay home long enough to get back the interest paid upfront. If a buyer sells the house after a few years, refinances, or cancels the mortgage, buying discount points can result in a loss of money.

Below is an example of how discount points can lower the cost of a $200,000 and a 30-year fixed-rate mortgage.

Principal loan     $ 200,000     $ 200,000

Interest rate     4%     3.5%

Discount points     None     $4000 

Monthly payment     $ 954     $ 898

Total interest     $ 144,016     $ 123,336

Lifetime Savings     None     $ 20,680

 

In this example, the borrower purchased two discount points, each costing 1% of the principal loan or $ 2,000. By purchasing two points upfront for $ 4,000, the borrower's interest rate was reduced to 3.5%, reducing their monthly payment by $56 and saving $ 20,680 in interest over the life of the loan.

To calculate the "breakeven point" at which the borrower will get back what they spent on up-front interest, divide the cost of mortgage points by the amount saved at the reduced rate each month: $ 4000/$ 56 = 71 months.

This shows that the borrower must stay at home for 71 months, or nearly six years, to recoup the discount points' cost.

The additional mortgage cost of falling interest rates makes sense if you plan to hold your home for an extended period. Otherwise, the likelihood of recovering this cost is minimal.

 

What are Mortgage Origination Points?

There are other types of mortgage points called "origination" points. Collection points are the fees paid to creditors for creating, reviewing, and processing the loan. Origination points typically cost 1% of the total mortgage amount. Therefore, if a borrower asks for 1.5 origination points for a mortgage of $ 250,000, he or she must pay $ 4,125.

Sometimes the origination points can be negotiated. Buyers who have lost 20% and have high credit have greater bargaining power.

A great credit score and high income will put you in the best position, and lenders can lower their reduction points to attract more qualified lenders.

 

Mortgages Points and ARM Loans

Mortgage points on an Adjustable Rate Mortgage (ARM) work like points on a Fixed Rate Mortgage. Still, most ARMs adjust over five or seven years, so knowing the cutoff is an even more important profitability before buying reduction points.

Consider the likelihood that you will end up refinancing that variable rate, as you may not have a loan long enough to qualify for the lower rate you get when you pay your points.


Is Mortgage Points Tax Deductible?

Mortgage repayment points, which are interest paid in advance, are tax-deductible up to $ 750,000 of mortgage debt. Taxpayers claiming a deduction for mortgage interest and deduction points should include the deduction on Schedule A of Form 1040.

In general, this is not a problem for home buyers, as mortgage interest rates are often sufficient to make the list deductions more advantageous than the standard deduction.

However, if you do not meet several IRS requirements, you cannot deduct all of the points paid in the same fiscal year. Only the amount of interest applied as mortgage interest for that year can be deducted each year. Points are diminished over the life of the loan and not over one year.

On the other hand, the origination points are not tax-deductible.

Points that are not interest, but charged for services such as mortgage preparation, appraisal fees, or notary fees cannot be deducted. 

 

Bottom Line

Buying mortgage points can save you a lot of money if you can pay and plan to stay home long enough to take advantage of the interest savings.

However, for many homeowners, paying discount points on top of other home-buying costs is a huge financial strain. Also, buying points is not always the best strategy to reduce interest charges. It may make financial sense to allocate these funds to a larger flow. 

A more substantial down payment can result in a better interest rate because it reduces the value of your loan or LTV, which is the size of your mortgage relative to the value of your home.

In general, buyers should consider all of the factors that can determine how long they intend to stay in their homes, such as the home's size and location and their work situation, and then estimate how long they will stay in their homes. It will take them to separate just before that to buy mortgage points.


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