Mortgage Calculator
Mortgage Articles
Mortgage Glossary
|
| Back to Articles Main Page |
| When Should You Pay Points on a Loan? |
| 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. |
