When
it comes
to comparing
interest
rates for
a mortgage
loan, homebuyers
often have
the option
of choosing
a loan with
a lower
interest
rate by
paying points.
Simply put,
a point
is equal
to 1 percent
of the loan
amount.
For example,
with a $100,000
loan, one
point equals
$1,000.
Points are
usually
paid out-of-pocket
by the buyer
at closing.
Paying
points
may seem
attractive,
because
a lower
interest
rate means
smaller
monthly
payments.
But is
paying
points
always
a good
idea?
The answer
generally
depends
on how
long you
plan to
stay in
the house.
Let's
look at
an example:
Bob
and Betty
Smith
are shopping
for loan
rates
on a $150,000
home.
Their
bank has
offered
them a
30 year
loan at
7.5 percent
with no
points.
This works
out to
a monthly
payment
of $1,049.
However,
their
bank has
also offered
them a
loan at
7 percent
if they
agree
to pay
2 points
(or $3,000).
At this
lower
rate,
their
monthly
payment
drops
to $998,
or a savings
of $51
per month.
By
dividing
the amount
they paid
for the
points
($3,000)
by the
monthly
savings
($51),
we see
that they
will have
to own
the house
for 59
months
(or just
under
5 years)
before
they will
start
to see
savings
as a result
of paying
points.
If Bob
and Betty
plan to
stay in
the house
for many
years,
then paying
points
could
make good
sense.
But if
they see
themselves
moving
to another
house
in the
near future,
they'd
be better
off paying
the higher
interest
and no
points.
(Note:
for simplicity,
the above
example
does not
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
United
States,
one side
benefit
of paying
points
on a mortgage
loan is
that they
are fully
tax deductible
for the
same tax
year as
your closing.
However,
this does
not apply
to points
paid for
a refinance
loan.
For refinances,
the IRS
requires
you to
spread
out the
deduction
over the
life of
the loan.
For example,
if you
paid $5,000
in points
for a
30-year
refinance
loan,
you can
only deduct
1/30 of
the $5,000
each year
for 30
years.
If you
pay off
the loan
early,
though,
you can
deduct
the remaining
amount
that tax
year.
