Tax Pointers on Mortgage Points

As of July 26, 2023, the average rate on a 30-year fixed-rate mortgage had risen to 7,33%, while the rate for a 15-year fixed rate mortgage bumped up to 6.56%. These rates are significantly higher than they have been in recent years. If you’re in the market for a mortgage for a new home purchase or hope to refinance an existing mortgage, you may now decide to pay one or more “points” to obtain a more favorable rate.

That begs the question: Is the full amount of points currently deductible on your personal tax return? Usually, the answer is “yes” if you’re taking out a new mortgage. However, if you’re refinancing an existing loan, the deduction for points is spread out over a period of years.

Background: A point is equal to 1% of the amount you’re borrowing from the lending institution. For instance, if you are charged two points on a $500,000 loan, it costs you $10,000. But it is generally worthwhile to pay the extra amount if it you will save tens of thousands in the long run.

Points paid on a new mortgage are fully deductible if you meet certain tax law requirements. Notably, the acquisition debt must be secured by your principal residence and you must reside in an area where paying points is an established business practice. The points are deducted along with mortgage interest on your return if you itemize deductions rather than claiming the standard deduction.

But there’s a twist if you’re refinancing an existing acquisition debt instead of taking out a new loan. In this case, you must amortize the points over the life of the refinanced loan.

Example: For simplicity, say you can obtain a more favorable rate for a 10-year mortgage if you pay one point. The loan principal is $200,000, so you have to dig into your pocket to pay the $2,000. As a result, you deduct $200 each year for the next ten years.

Conversely, for a home equity loan or line of credit (when permitted by state law), the rules differ again. Under the Tax Cuts and Jobs Act (TCJA), the deduction for mortgage interest paid on home equity debt has been suspended for 2018 through 2025. However, the loan can still qualify as acquisition debt if the proceeds are used for substantial home improvements. Therefore, you may be able to write off the points, subject to the rules for acquisition debt.

Note: If you use home equity loan proceeds for other purposes—for instance, to buy a car or go on a vacation—the loan is treated as home equity debt. So you get no deduction whatsoever.

Finally, if interest rates begin to trend downward in the future, you might decide to refinance a mortgage a second or even third time. Now you qualify for an immediate tax break on the points, plus you can deduct full amount of points remaining from the prior refinancing. You no longer have to amortize those points.

In summary: As you can see, the tax rules for points can be tricky. Contact your professional tax advisor regarding your circumstances.