In our previous article we looked at mortgage interest deductions. Now we go through the details of whether points paid are also deductible or not and if they are, would the full amount of points be deductible in the year they are paid.

But let us first start by looking at what are points. Points generally are the charges paid or treated as paid by borrower to get a mortgage. These are also called as loan discount, maximum loan charges, discount points or loan origination fees.

A borrower can fully deduct points in the year they are paid if the under mentioned conditions are satisfied. If all these conditions are not met then borrower has to deduct them equally (ratably) over the term of the loan only if certain other requirements are fulfilled (we will look at those requirements in the following sections).

Points deduction allowed in the year they are paid if –

1. Paying points is a common business practice in the area where the mortgage was made.

2. Borrower uses cash method of accounting. It means that borrower reports income in the year it is received & deducts expenses in the year they are paid (a good percentage of individuals use this method).

3. The mortgage is secured by borrower’s main home. (Main home is defined as the one in which borrower lives in most of the time)

4. Points paid are not more than what are normally charged in the area borrower lives.

5. Funds borrower provides before or at closing plus any points seller pays, are at least equal to the points charged. Funds borrower provides need not be applied to the points. It can be used for down payment, earnest money, escrow deposit or other similar funds borrower pays for before or at closing. But these funds cannot be borrowed from mortgage broker or lender.

6. Points were not paid in place of fees which are ordinarily stated separately on settlement statement, like, title fees, appraisal fees, attorney fees, inspection fees, & property taxes.

7. Points paid are computed as a percentage of mortgage’s principal amount.

8. The amount is shown on settlement statement as points charged for the loan. It is however allowed to show the points as paid from either seller’s or borrower’s funds.

9. The mortgage is used by borrower to build or buy his main home.

If all the above mentioned conditions are met then borrower can select between either deducting them over the term of his mortgage or fully in the year they are paid.

Now what happens if the mortgage was taken for home improvements, a second home or if it was a refinance mortgage?

• Borrower can fully deduct the points in the year they are paid on a mortgage taken for home improvements if the first six conditions mentioned above for “points deductions allowed in the year paid” are met.

• For a second home borrower cannot fully deduct points the same year they are paid. These can only be deducted over full term of the loan.

• Points paid to refinance a mortgage cannot be deducted in full in the year they are paid. However, if part of the proceeds of the refinanced mortgage are used to make home improvement & the first six above mentioned conditions are fulfilled then borrower can fully deduct that part of points which is related to the improvements in the same year they are paid from own funds. Rest of the points will have to be deducted ratably over the term of the mortgage.

If a borrower cannot meet the conditions to be able to fully deduct points in the year they are paid, mortgage is not taken for home improvements or he selects not to deduct them in the same year, then those points can be deducted equally over full term of the mortgage if following conditions are met:

a) Mortgage is secured by a home (need not be the main home).

b) If mortgage if for more than 10 years, then loan terms are same as those for other loans offered in borrower’s area for same or longer periods.

c) Borrower uses cash method of accounting.

d) Mortgage period is not more than 30 years.

e) Mortgage is for $250,000 or less, or number of points is not greater than –

i. 4, if mortgage is for 15 or less years, or

ii. 6, if mortgage is for more than 15 years.

Many borrowers think of certain amounts charged by a lender for specific services like, notary fees, VA funding fees, appraisal fees, mortgage insurance premiums, and preparation costs for the deed of trust or mortgage note as part of points. But it is not true; these amounts cannot be deducted as points in the year they are paid or over the term of the loan.

This entry was posted on Monday, October 22nd, 2007 at 6:17 am and is filed under Mortgage. You can follow any responses to this entry through the RSS 2.0 feed. Both comments and pings are currently closed.