This Financial Guide explains when and to what extent points paid on the purchase of a home or on a refinancing are deductible. It explains the rules for deducting points and discusses special circumstances and situations.
Table of Contents
Note: For an explanation of the deductibility of home mortgage interest, please click here.
What Are Points?
The term "points" is used to describe certain charges paid, or treated as paid, by a borrower to obtain a home mortgage. Points may also be called loan origination fees, maximum loan charges, loan discount, or discount points.
Points are prepaid interest and may be deductible as home mortgage interest, if you itemize deductions on Form 1040, Schedule A. Generally, if you can deduct all of the interest on your mortgage, you may be able to deduct all of the points paid on the mortgage. If your acquisition debt exceeds $1 million or your home equity debt exceeds $100,000, you cannot deduct all the interest on your mortgage and you cannot deduct all your points.
A borrower is treated as paying any points that a home seller pays for the borrower's mortgage. See "Points Paid by Seller," later.
Tests for Deductibility
Generally, you cannot deduct the full amount of points in the year paid. Because they are prepaid interest, you generally must deduct them over the life (term) of the mortgage.
However, you can fully deduct points in the year paid if you meet all of the following tests.
- Your loan is secured by your main home (the one you live in most of the time).
- Paying points is an established business practice in the area where the loan was made.
- The points paid were not more than the points generally charged in that area.
- You use the cash method of accounting (the method used by most individual taxpayers).
- The points were not paid in place of amounts that ordinarily are stated separately on the settlement statement, such as appraisal fees, inspection fees, title fees, attorney fees, and property taxes.
- You use your loan to buy or build your main home.
- The points were computed as a percentage of the principal amount of the mortgage.
- The amount is clearly shown on the settlement statement (such as the Uniform Settlement Statement, Form HUD-1) as points charged for the mortgage. The points may be shown as paid from either your funds or the seller's.
- The funds you provided at or before closing, plus any points the seller paid, were at least as much as the points charged. The funds you provided do not have to have been applied to the points. They can include a down payment, an escrow deposit, earnest money, and other funds you paid at or before closing for any purpose. You cannot have borrowed these funds from your lender or mortgage broker.
Home improvement loan. You can also fully deduct in the year paid points paid on a loan to improve your main home, if statements (1) through (5) above are true.
Amounts charged by the lender for specific services connected to the loan are not interest. Examples of these charges are:
- Appraisal fees
- Notary fees
- Preparation costs for the mortgage note or deed of trust
- Mortgage insurance premiums
- VA funding fees.
You cannot deduct these amounts as points either in the year paid or over the life of the mortgage.
Points Paid by Seller
The term "points" includes loan placement fees that the seller pays to the lender to arrange financing for the buyer. The seller cannot deduct these fees as interest. But they are a selling expense that reduces the seller's amount realized. The buyer reduces the basis of the home by the amount of the seller-paid points and treats the points as if he or she had paid them. If all the tests explained earlier are met, the buyer can deduct the points in the year paid. If any of those tests is not met, the buyer deducts the points over the life of the loan.
Funds Provided Are Less than Points
If you meet all the tests referred to earlier; except that the funds you provided were less than the points charged to you (test 9), you can deduct the points in the year paid, up to the amount of funds you provided. In addition, you can deduct any points paid by the seller.
Example: When you took out a $100,000 mortgage loan to buy your home in December, you were charged one point ($1,000). You meet all the nine tests for deducting points in the year paid, except the only funds you provided were a $750 down payment. Of the $1,000 charged for points, you can deduct $750 in the year paid. You spread the remaining $250 over the life of the mortgage.
Example: The facts are the same as in Example 1, except that the person who sold you your home also paid one point ($1,000) to help you get your mortgage. In the year paid, you can deduct $1,750 ($750 of the amount you were charged plus the $1,000 paid by the seller). You must reduce the basis of your home by the $1,000 paid by the seller.
If you meet all the tests except that the points paid were more than generally paid in your area (test 3), you deduct in the year paid only the points that are generally charged. You must spread any additional points over the life of the mortgage.
Points Paid on Second Home
The general rule of instant deductibility does not apply to points you pay on loans secured by your second home. You can deduct these points only over the life of the loan.
Mortgage Ends Early
If you spread your deduction for points over the life of the mortgage, you can deduct any remaining balance in the year the mortgage ends. However, if you refinance the mortgage with the same lender, you cannot deduct any remaining balance of spread points. Instead, deduct the remaining balance over the term of the new loan.
A mortgage may end early due to a prepayment, refinancing, foreclosure, or similar event.
Example: Dan paid $3,000 in points in 2006 that he had to spread out over the 15-year life of the mortgage. He had deducted $1,200 of these points through 20011. Dan prepaid his mortgage in full in 2008. He can deduct the remaining $1,800 of points in 2012.
Points Paid on Refinancing
Generally, points you pay to refinance a mortgage are not deductible in full in the year you pay them. This is true even if the new mortgage is secured by your main home.
However, if you use part of the refinanced mortgage proceeds to improve your main home and you meet the first five tests listed earlier; you can fully deduct the part of the points related to the improvement in the year paid. You can deduct the rest of the points over the life of the loan.
Example: In 1999, Bill Fields got a mortgage to buy a home. The interest rate on that mortgage loan was 11%. In 2008, Bill refinanced that mortgage with a 15-year $100,000 mortgage loan that has an interest rate of 7%. The mortgage is secured by his home. To get the new loan, he had to pay three points ($3,000). Two points ($2,000) were for prepaid interest, and one point ($1,000) was charged for services, in place of amounts that ordinarily are stated separately on the settlement statement. Bill paid the points out of his private funds, rather than out of the proceeds of the new loan. The payment of points is an established practice in the area, and the points charged are not more than the amount generally charged there. Bill's first payment on the new loan was due July 1. He made six payments on the loan in 2008 and is a cash basis taxpayer.
Bill used the funds from the new mortgage to repay his existing mortgage. Although the new mortgage loan was for Bill's continued ownership of his main home, it was not for the purchase or improvement of that home. For that reason, Bill does not meet all the tests, and he cannot deduct all of the points in 2008. He can deduct two points ($2,000) ratably over the life of the loan. He deducts $67 [($2,000 ÷ 180 months) x 6 payments] of the points in 2008. The other point ($1,000) was a fee for services and is not deductible.
Example 2: The facts are the same as in Example 1, except that Bill used $25,000 of the loan proceeds to improve his home and $75,000 to repay his existing mortgage. Bill deducts 25% ($25,000 ÷ $100,000) of the $2,000 prepaid interest in 2008. His deduction is $500 ($2,000 x 25%).
Bill also deducts the ratable part of the remaining $1,500 ($2,000 - $500) prepaid interest that must be spread over the life of the loan. This is $50 [($1,500 ÷ 180 months) x 6 payments] in 2008. The total amount Bill deducts in 2008 is $550 ($500 + $50).
Limits on Home Mortgage Interest Affect Points
You cannot fully deduct points paid on a mortgage that exceeds the limits on home mortgages for purposes of the home mortgage interest deduction.
The mortgage interest statement (Form 1098) you receive should show not only the total interest paid during the year, but also your deductible points.
The statement will show the total interest you paid during the year. If you purchased a main home during the year, it also will show the deductible points paid during the year, including seller-paid points. However, it should not show any interest that was paid for you by a government agency.
As a general rule, Form 1098 will include only points that you can fully deduct in the year paid. However, certain points not included on Form 1098 also may be deductible, either in the year paid or over the life of the loan. See the earlier discussion of Points to determine whether you can deduct points not shown on Form 1098.