Loan Points For Home Buyers

This system of points is used for making payments towards the interest rate of a loan. This in turn lowers the monthly payment liability. The borrower or homebuyer pays it to the lender for taking out the loan. A point is equal to 1% of the loan. For example, one point on a $100,000 loan is equal to $1000. Points ranges from 0 to 3 depending on the loan program. If a buyer seeks lower interest rate on a loan, he/she must be paid more points. If a buyer wants to pay fewer points, he/she must settle for a higher interest rate. Exempli-gratia, 1.25 points is equal to 0.25% of interest rate. In this way 7.75% interest rate with 0 points could be lowered to 7.50% interest rate with 1.25 points or 7.25% interest rate with 2.5 points.

In reality the savings from these lower monthly payments will pay for the extra points paid for at the closing. Usually it takes several years for the points on a loan to pay for itself. If a buyer sells the house within 5 years, he could be losing part of the points that were paid up front. In such cases it would be better that buyer pay the higher interest rate.

Such points can be deducted by a buyer as mortgage interest. But he/she has to spread his/her deduction for points over the entire tenure of the loan. Even though he/she has actually paid the amount in the first year. There is an exception however, which allows many borrowers to deduct their points in the year paid. The conditions under which a buyer can deduct points in the year he/she pays them are:

• The loan is utilized for buying, building or improving the principal house. Thus, second mortgage or home equity loans qualify if the proceeds are used for home improvement but not otherwise.
• It is an established practice among buyers to make the payment of points. The points paid don't exceed the number of points generally charged in the area. If lender of the buyer charges three points and buyer pay four, buyer in such cases can deduct the first three points in the first year. The fourth point must be deducted over the entire term of the loan. 
• The points are not alternative payment instruments for charges towards appraisal, inspection, title, or attorney fees.
• The points are clearly mentioned on the settlement statement as points charged for mortgage. They are computed as a percentage of the principal amount of the mortgage.
• If the purpose of the loan had been to buy the buyers main home, then he/she must have provided funds at the time of closing. Those are at least equal to the points charged, outside of the money obtained from the lender. For such purposes, the funds provided by the buyer need not be applied specifically as payment of point; they can be applied to buyer's down payment, earnest money, or other funds actually paid over at the closing.
• The cash method of accounting must be applied by the buyer, which is the most common method of keeping track of their income and expenses.

When the points are deducted it is generally applicable to the buyers, and not for the sellers, of home. If the seller pays some points that enables the buyer to get a loan, the buyer may deduct the points. The seller treats the amount paid as a selling cost that helps to reduce his or her taxable profit on the sale made.

A buyer's main house comes under the purview of these rules. If buyer pays points on a loan secured by a second home, those points can only be deducted over the entire term of the loan. Points paid in refinancing a mortgage on buyers main home are generally not deductible in the year paid. They must be prorated and deducted over the entire loan period. However, if the proceeds of mortgage refinancing are used both to pay off the old mortgage and to pay for home improvements, the portion of the points that pertain to the home improvements can be deducted in the first year. The examining portion must be prorated over the loan's entire term.

You must remember that these points are not refundable. This is a negative aspect of this system. A buyer engaging a lot of money upfront will not get a pro-rate refund if he/she decides to move or mortgage refinance before the loan term is over. Even worse, if a buyer wishes to put 20 percent down on his/her new home, the point could pay him/her on the wrong side of the equation, and cost him a fortune for private mortgage insurance.

Deduction Of Points On Income Tax

A buyer stands to gain a one sided benefit of paying points on a mortgage loan in the United States. As they are fully tax exempted for the same financial year at the time of closing. However, this does not apply to points paid for a refinance loan. For refinances, the IRS requires the buyers to spread out the deduction over the tenure of the loan. For example, if a buyer paid $5,000 in points for a 30-year refinance loan, buyer can only deduct 1/30 of the $5,000 each year for 30 years. If buyer pays off the loan early, he/she can deduct the remaining amount that tax year.

Therefore, the "Point" is not only helpful for lower interest rate but also for the deduction of points on income tax. So a buyer can take advantage of the "point" facility to overcome his/her financial situation at the time purchasing a new house.

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