Factoring points into your mortgage costs

Points can be a way to save on your monthly mortgage payments. 

These are fees that are equal to 1 percent of your home loan amount. There are two types of points: origination and discount points. The first is a fee charged as compensation for the loan officers. Not all lenders will add origination points, which are not tax deductible, and they can add one or more to your mortgage. The latter is a lump sum payment that allows you to lower your interest rate on the loan. Each discount point you purchase decreases the interest rate, and they are tax deductible. Borrowers can typically add up to three of these points.

Here are some factors to consider when deciding whether to purchase discount points:

• How long do you want to stay in the home? With a lower interest rate, you figure to save a lot of money over the life of your mortgage, but this is only possible if you don't move for a while. Calculate how much your points will cost and how long it will take to break even through your monthly savings. You can then determine whether you should purchase fewer or any points at all.
• How much can you afford at closing? Points are purchased when you close the loan, which means you'll need to bring more money to the table. Depending on your budget, which can already be stretched for your closing costs and down payment, you may not be able to afford points.

Deducting discount points

Points can be deducted in full in the year that they are paid. The IRS has nine guidelines for when you can claim a deduction:

1. The mortgage has to be for your primary residence.
2. The loan has to be used to buy or build said residence.
3. The points have to be calculated as a percent of the principal amount of your home loan.
4. The amount has to be shown as points on your settlement statement.
5. Any funds you provide at or prior to closing, plus any points paid by the seller, must be at least as much as the points charged, and you can't have borrowed from your lender to pay for the points.
6. Paying points must be an established business practice in your area.
7. The points charged cannot be more than the amount generally paid in your area.
8. Your income has to be reported in the year you earn it, and your expenses have to be reported in the year you pay them.
9. The points cannot be used for items separately stated on the settlement sheet, such as property inspection fees.