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Points are fees paid to a lender at closing, usually to lower the interest rate on a mortgage. Because they are really prepaid interest, they can often be deducted, but the timing and the conditions depend on what the points were for.

What counts as points

Points are typically listed on the settlement statement as loan discount points or origination points and are charged as a percentage of the loan. Fees for services, such as appraisals, title work, credit reports, notary fees and attorney charges, are not points and are not deductible as interest.

Points on a home purchase

When you buy your main home, points may be deductible in full in the year you pay them if all of these are generally true:

• The loan is secured by your main home.
• Charging points is an established business practice in your area, and the amount is not unusual.
• The points are computed as a percentage of the loan and are clearly shown on the settlement statement.
• You use the cash method of accounting, which most individuals do.
• The funds you provided at or before closing, including your down payment, were at least as much as the points, excluding amounts paid by the lender or seller.

Points paid by the seller are treated as paid by you, though you reduce your cost basis in the home by that amount.

Points on a refinance

Points paid to refinance are usually not deducted all at once. Instead, you spread the deduction evenly over the life of the new loan. If you later pay off the loan early, for example by refinancing again or selling, you can generally deduct the remaining balance of those points in that year. If part of the refinance proceeds was used to improve your home, that portion may qualify for a faster deduction.

Second homes and other loans

Points on a second home or an investment property generally must be spread over the life of the loan. Points on a home equity loan follow similar rules, depending on how the funds are used.

Itemizing

As with other mortgage interest, deducting points helps only if you itemize and your total deductions exceed the standard deduction. Keep your closing documents and Form 1098, since points are sometimes reported there and sometimes not.

The IRS covers this in Publication 936 at irs.gov. If you are deciding whether paying points makes financial sense, or how to report them, talk with us before you close if you can.