If you ever decide to take the plunge and buy a home, your mortgage will likely be the largest debt you'll ever take on. And as part of owning a home, you may be faced with fees in terms of mortgage points. However, paying mortgage points can sometimes make good financial sense, and you can often deduct points on your taxes.
What are mortgage points?
A home mortgage point is equal to one percent of the amount of your loan. For example, if you have a $100,000 home loan, one point is the equivalent of $1,000. The home mortgage industry uses two types of points, origination points and discount points. Origination points are typically income for the loan originator, while discount points are a type of prepaid interest and are often fully deductible.
Qualifying for a deduction
Generally, the Internal Revenue Service (IRS) allows you to deduct the full amount of your points in the year you pay them. If the amount you borrow to buy your home exceeds $1 million ($750,000 for new mortgages beginning in 2018), you are generally limited on the amount of points that you can deduct. The IRS also imposes the following requirements to deduct mortgage points:
- The mortgage must be used to buy or build your primary residence
- The points must be a percentage of your mortgage amount
- The use of points must be a normal business practice in your area
- The amount of points paid must not be excessive for your area
- You must use cash accounting on your taxes
- The points must not be used for items that are typically stand-alone fees, such as property taxes
- You cannot have borrowed the funds to pay for the points from the mortgage lender or broker
- The amount you pay must be clearly itemized as points on your statement
If you aren't able to deduct your points in the year you pay them, you may still qualify to deduct them over the life of the loan.
How to Deduct Points
As far as filing taxes goes, claiming a tax deduction for mortgage points is a fairly straightforward process. Mortgage points are considered an itemized deduction and are claimed on Schedule A of Form 1040. Here are the specifics:
- Usually, your lender will send you Form 1098, showing how much you paid in mortgage points and mortgage interest
- Transfer this amount to line 10 of Form 1040 Schedule A
- If any of your points were not included on Form 1098, enter the additional amount you paid on line 12 of Form 1040 Schedule A
For many taxpayers, the process really is this simple. In some cases, though, calculating and deducting mortgage points can be tricky. With TurboTax, just answer a few simple questions and we can help you get the proper deduction for your mortgage points.
Benefits add up
On the surface, paying additional costs when trying to negotiate the best price for a home might not seem logical. But with many lenders, each discount point you pay up front results in a reduction of your loan rate, typically by 0.25%. For example, if you agree to a 4% mortgage, paying two points upfront might result in your loan rate dropping by 0.50%, to 3.5%.
Adding in the benefit of deducting those points on your taxes, it could be the right financial move. Generally, the longer you intend to stay in your home, the more benefit you could get from paying mortgage points upfront and lowering your monthly interest rate.
More money upfront
Part of the joy of looking for a home is finding the nicest one you can afford. However, some home buyers overlook the effect mortgage points can have on home affordability. Generally, mortgage points must be paid upfront, in addition to a down payment.
If you've decided to buy a home where you can just barely make the down payment, paying additional money for mortgage points could be a deal breaker. Additionally, if you don't closely follow IRS rules, you may not qualify for a tax deduction.
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