When To Pay Up Front “Points” On A Mortgage Loan

Should You Pay Points on a Loan?

Homebuyers often have the option of choosing a mortgage with a lower interest rate by paying points. A point is equal to 1% of the loan amount. Ex: With a $100,000 loan, one point equals $1,000. Points are usually paid, out-of-pocket by the buyer at closing.

Paying points can be attractive because a lower interest rate means smaller monthly payments. But is it always a good idea? The answer generally depends on how long you plan to stay in the house. Here’s an example:

Dave and Rhonda Jennings are shopping for a $300,000 home. They have $60K in cash, 50K for a down payment, and 10K for closing costs. The bank has offered a $250,000, 30-yr loan at 4% with no points. Their monthly P&I payment would be $1193.54

Their bank has also offered a 30-yr loan at 3.5% if they agree to pay 2 points (or $5000). At this lower rate, their monthly payment drops to $1122.61, or a savings of $70.93 per month.

Dividing what they paid for points ($5,000) by the monthly savings ($70.93), tells us they’ll have to own the house for just under 6 yr’s before they start seeing savings. If they plan to stay in the house for many years, then paying points could make good sense. But if they plan to move in the near future, they’re better off paying the higher interest and no points. (For simplicity, the above example doesn’t take into account the time value of money, which would slightly lengthen the break-even time.)

Can you deduct points on your income taxes?
In the USA, a side benefit of paying points is that they are fully tax deductible for the same tax year as your closing. But this doesn’t apply to points paid for a refinanced loan. For Re-Fi’s, the IRS requires you to spread the deduction over the life of the loan. Ex: If you paid $5,000 in points for a 30-yr Re-Fi, you can only deduct 1/30 of the $5,000 each year for 30 years. But, if you paid off the loan early, you can deduct the remaining amount that tax year.

Note: This information is provided as a general outline.  Any finance scenarios with tax implications are best addressed with your tax professional, and lender.