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Understanding Mortgage Discount Points

Posted by MARK Z on Thursday, May 9th, 2019 at 10:46am.

Buying a new home is an exciting step, which can mean different things to different people. For some people, a new home purchase means financial independence. For others, a new home is a start to a new family or a new job. Whatever it may mean to you, it’s something to do with careful forethought. Since you’ll most likely be staying in your home for several years or maybe for good, you want to make the wisest financial decision. Approved mortgage application with keys on the paperwork

One of the strategies of purchasing a new home is to buy mortgage points upfront. Let’s take a closer look at how mortgage points work.

What are Mortgage Points?

Mortgage points are points you can purchase upfront that will lower your interest rate. They are often referred to as discount points because they give you a discount on your monthly mortgage payment by reducing the interest fee.

Mortgage points cost 1 percent of the mortgage value or $1,000 for every $100,000. This will reduce your monthly payment. Most lenders will allow you to purchase between one and three discount points. The bottom line is lenders will enable you to buy a lower rate for your home’s interest by offering you these discount points.

Are Mortgage Points Worth it?

You may be wondering if it’s worth it to buy mortgage points. Maybe you are not sure if you want to put any more money into the home upfront. It pays to work the numbers to see if it will be beneficial in your situation. For example, let’s suppose you want to purchase a home that costs $200,000. One point will cost $2,000, and two points will cost $4,000. At an APR interest rate of 4.5 percent, one point will bring it down to 4.25 percent for a monthly savings of $29.49. For two points, the rate drops to 4 percent for a monthly savings of $58.54. Throughout the 30-year loan, the total savings on one point is $10,616.40 and the savings on two points is $21,074.40.

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It’s important to note how long it takes to break even on your point purchase. To figure this out, you divide the amount you paid for the points by the amount you save each month. So, using the example above, if you purchased one point for $2,000 and your monthly savings is $29.49, you will break even in 68 months or five and a half years.

When deciding whether you should purchase discount points, there are a couple of things to determine. How long you plan to stay in the home is an important consideration. If you aren’t going to stay long enough to break even or you only plan to stay a few years past that time, then it probably isn’t worth it. The best-case scenario for purchasing points is if you plan to live in the home for the duration of the loan. That will give you substantial savings.

Another issue you’ll have to consider concerning discount points is whether you have the extra cash up front to buy them. Depending on the cost of your home and the amount of your down payment, you may not have additional money to put towards it. However, if you already have your down payment covered and the seller is paying some of the closing costs, then it may be a good move for you.

Tax Deductibility for Mortgage Discount Points

Before the new tax laws established in 2017 and that went in effect for 2018 and beyond, discount points were tax deductible on Schedule A. There are some slight modifications and stipulations to the law regarding discount points. The IRS states that you can deduct discount points if the following conditions are met (Source: IRS publication: Topic Number 504):

  1. Your main home secures your loan (your main home is the one you live in most of the time).

  2. Paying points is an established business practice in the area where the loan was made.

  3. The points paid weren't more than the amount 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 paid weren't for items that are usually listed separately on the settlement sheet such as appraisal fees, inspection fees, title fees, attorney fees, and property taxes.

  6. The funds you provided at or before closing, including any points the seller paid, were at least as much as the points charged. You can't have borrowed the funds from your lender or mortgage broker in order to pay the points.

  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, and

  9. The amount shows clearly as points on your settlement statement.

Whatever you decide to do, it’s best to discuss your options with a trusted real estate agent. For more information, get in touch today!

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