Mortgage points are mortgage closing costs that are paid when closing a residential home loan. Mortgage points are often used for an interest rate buy down. One point equals one percent of the mortgage loan amount.
Who pays for the mortgage points depends on the purchase contract. The buyer pays the mortgage points in most cases; however, a seller can pay for the mortgage points via seller concessions.
Mortgage Points
Mortgage points are broken down into two categories: origination points and discount points.
Origination Points
Origination points are typically a form of revenue for mortgage lenders. In other words, they are a fee charged for profit.
Origination points are different than “origination charges”. Origination charges are the normal lender fees. See our estimated closing costs for a breakdown of fees.
Origination points are typically company specific. For example, traditional banks that happen to do mortgages often charge origination points on their loans. This is how they make additional money. By contrast, most mortgage bankers (like us) don’t charge origination points.
The Mortgage Mark Team does not typically charge origination points.
Discount Points
Discount points are more specific to the loan and can be charged for a variety of reasons.
These are common instances where discount points are charged:
- when escrows are waived
- credit scores are low
- lock extensions,
- extended rate locks,
- an interest rate buy down.
When escrows are waived, there is typically a .25% discount point charged. This is a charge that is accessed by Fannie Mae and Freddie Mac.
Discount points can be charged when the rate has a large adjustment due to lower credit scores. Occassionly there isn’t an option for a “par” interest rate (i.e. a rate with zero mortgage points).
Locks have expiration dates. In most cases, there is a charge to extend the lock beyond the expiration date. These costs are typically shown as discount points.
When doing an extended lock, there is an upfront cost to lock in a rate. See our extended rate lock program for more details on the exact cost when locking a rate for as long as 12 months.
Interest Rate Buy Down
Discount points can be associated with a permanent interest rate buy down. The revenue from a discount point is offset by the expense of a lower rate. In other words, the discount points aren’t typically profit for a lender.
Here’s an example: let’s assume the interest rate is X% for a no-point loan. The borrower wants to lower the interest rate by .25% and pays one point (1% of the loan amount) to get that rate. By paying the additional money they are able to reduce the interest paid over the life of the loan.
When to Pay Points
Paying mortgage points isn’t always financially prudent. Calculate the breakeven period to determine the true benefit of the mortgage points.
“Buy Down” Break Even Point Calculator
You don’t need a special “points calculator” to determine the amount of mortgage points being charged. There are three steps to determine if is it worth paying points:
- Calculate the amount of mortgage points being charged
- Determine the monthly savings from the lower interest rate
- Figure out the break even point – i.e. how long before the savings justify the costs
Calculate Points Charged
One mortgage point on a $200,000 loan amount results in a $2,000 discount point since a point is 1% of the loan amount. For another example, on the same $200,000 loan amount a half a point (.5%) would be $1,000.
Mortgage points can be any amount but typically range from 0%to 2%. Let’s assume $2,000 in discount points are being charged for our example.
Determine Monthly Savings with Lower Rate
Now let’s assume the $200,000 loan amount has an interest rate of X% and that paying one point of $2,000 (1% of the loan amount) will lower the interest rate by .25%. This will result in about a $30 per month savings.
Break Even Point
Taking the points paid ($2,000) and dividing it by the monthly savings ($30) results in a 66.6 month break even, or 5.5 years (66 months / 12). This means the monthly savings will justify the costs if someone plans on keeping the mortgage for longer than 5.5 years.
Let’s do another quick example but have the costs be two points (2%) to save the .25% in rate. The break even point calculation would be $4,000 / $30 = 133 months = 11 years. In this instance it really doesn’t make sense to pay $4,000 today and have to wait over a decade to see the benefit of saving only $30 per month.
Are Mortgage Points Tax Deductible?
First and foremost, consult your CPA for accurate tax advise.
Mortgage points are tax deductible so long as they are true discount points to buy down the interest rate. Because mortgage interest is tax deductible the mortgage points paid to lower the interest rate are like prepaying interest. Tax deductible points will typically appear as Discount Points – not Origination Points. The transaction type impacts the timing of when the tax deduction can be realized.
Tax Deduction for Purchases
Mortgage points paid at a purchase closing are deductible for that tax year. Mortgage points not paid directly by the buyer have to be prorated over the life of the loan.
For example, if $1,000 in points were charged but the borrower only brought $750 to closing and the remaining $250 was paid via seller concessions or premium pricing, then only $750 is allowed to be deducted and the remaining $250 has to be spread out over the life of the loan.
Note: if the points paid were in excess for what is “common and customary” then the points need to be deducted over the life of the loan. Consult your CPA for what’s considered “common and customary.”
Tax Deduction for Refinances
Points paid in association of a refinance have to be allocated over the life of the loan. This includes Home Equity Lines of Credit (HELOC).
Tax Deduction for Second Homes
Any points paid for loan pertaining to a second home must be deducted over the life of the loan, regardless if it’s a purchase or a refinance.
Tax Deduction for Home Improvement Loans
All points paid in association with home improvement loans are tax deductible in the tax year that the points were paid.
Mortgage Ending Early
The timing on tax deductions for mortgage points changes when a mortgage ended early due to prepayment, refinance, or sale of the home.
Any “unused” portion of points that are being deducted for the life of the loan can be “accelerated” and deducted in full. The exception to this rule is that if the loan is refinanced with the same servicer. As a result the points still have to be allocated over the life of the loan.
Let’s be clear: you can use the same Loan Officer (i.e. us) multiple times over and have the points be deductible. It’s only when you refinance directly with the servicer that they can’t be accelerated.
Not Points: Funding Fees, MIP, and Participation Fees
There are home loan programs (like FHA, VA, Texas Vet, Bond Programs, etc.) that have charges that are based off loan amounts but these are NOT mortgage points.
Each program has unique name for these charges. FHA has an Upfront MIP (UFMIP), VA home loans have a “funding fee”, Texas Vet and Bond programs have “participation fees”.
In conclusion, these fees are not tax deductible as they are not considered true mortgage points.
Mark Pfeiffer
Branch Manager
Loan Officer, NMLS # 729612
972.829.8639
MortgageMark@MortgageMark.com
We assist clients with all type of mortgage loan programs