Mortgage Discount Points: How They Work and Tax Rules

What a discount point is

The CFPB describes points as a trade-off: you pay more up front and receive a lower interest rate, so you pay less over time.

• 1 point = 1% of the loan amount.
• Points do not have to be round numbers. The CFPB gives examples of 1.375 points ($1,375), 0.5 points ($500) and 0.125 points ($125) on a $100,000 loan.
• Points are paid at closing and added to your closing costs (see closing costs explained).
• By law, points listed on the Loan Estimate and the Closing Disclosure must be connected to a discounted interest rate.

Some lenders call any fee calculated as a percentage of the loan “points”, so ask each lender how a fee affects your rate.

Lender credits: points in reverse

Lender credits work the other way. You accept a higher interest rate and the lender pays part of your closing costs. On a lender’s worksheet they may be called “negative points”. They appear as a negative number on page 2, Section J of the Loan Estimate or Closing Disclosure.

A worked example from the CFPB

The CFPB uses a $180,000, 30-year fixed-rate loan at 5.0% with zero points. These figures are the CFPB’s illustration, not current market rates.

Simple arithmetic on this example: $675 ÷ $14 per month is about 48 months before the lower payment has repaid the points. If you sell or refinance before then, the points cost more than they saved.

How to compare offers with points

The CFPB recommends these steps:

1. Ask for the same number of points or credits from each lender. Pricing structures differ, so comparing a 1-point offer with a 0-point offer is misleading.
2. Ask for two versions (with and without points or credits) and the total cost over several timeframes: the shortest, the longest and the most likely period you will keep the loan.
3. Check page 2, Section A of each Loan Estimate for the points actually charged.

If you do not know how long you will stay or when you may refinance, the CFPB notes that paying points may not be worthwhile. If you may refinance, include that timeframe in the comparison.

Points on an adjustable-rate loan. The CFPB’s handbook on ARMs warns that paying points on an ARM often lowers the rate only until the end of the initial period, not over the life of the loan. See mortgage rates explained for how rates are set.

Tax treatment of points (IRS Topic 504 and Publication 936)

The IRS treats points as prepaid interest. You can only deduct them if you itemize on Schedule A (Form 1040). For the broader rules, see the mortgage interest deduction.

General rule: spread over the loan. Points to obtain a new mortgage, to refinance, or on a loan secured by a second home are generally deducted ratably over the term of the loan. Publication 936 gives this example: $4,800 of points on a 20-year loan, with 3 payments in the first year, gives a first-year deduction of $60 ($4,800 ÷ 240 months × 3).

Exception: full deduction in the year paid. Publication 936 lets you deduct points in full in the year paid if all of these tests are met:

• the loan is secured by your main home and used to buy or build it;
• paying points is an established practice in the area, and the amount is not more than is generally charged there;
• you use the cash method of accounting;
• the points were not paid instead of fees normally listed separately (appraisal, inspection, title, attorney fees, property taxes);
• the funds you provided at or before closing, plus any seller-paid points, were at least equal to the points charged, and were not borrowed from your lender or mortgage broker;
• the points were computed as a percentage of the principal and are clearly shown as points on the settlement statement.

Refinancing. Points paid to refinance are generally not deductible in full in the year paid, even when the new loan is secured by your main home. The part related to substantially improving your main home can be an exception.

Seller-paid points. The buyer treats them as if the buyer paid them and reduces the home’s basis by that amount.

Early payoff. If you were spreading points and the mortgage ends early, you can deduct the remaining balance that year. If you refinance with the same lender, you deduct the remaining balance over the term of the new loan instead.