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Should I buy points to buy down the mortgage?
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Question:
I am refinancing my house. Should I buy points to buy down the mortgage?Answer:
Let me point out something upfront. It is often argued that the points are deductible which can be a nice big deduction in the year when you buy them.But:
In a new purchase, points can be fully deducted in the first year.
In a refinance, you have to amortize the points over the life of the loan. This is usually 30 years unless you have 15 year amortization. Even if you have a 7/1 ARM or 10/1 ARM, amortization most likely is 30 years and you can write off a portion of your points each year. Now, if you have a 7/1 ARM and you sell after 5 years or refinance again, then there are 25 unused years of "the points' life". You can fully deduct the remaining portion of the points then.
Examples:
1) You buy a house and finance 300k. Buy 2 points = $6k
You have a $6k tax deduction in the first year. Nice and eaasy.
2) You refinance $300k, again buy 2 points = $6k. It's a 30yr loan. Each year you can deduct 1/30 of the $6k = $200. After 5 years you have deducted $1000 so far. Now you sell. You can deduct the remaining $5000 in the year of the sale.
Now, do points make sense from an interest perspective? Points mean that the bank gets some of the interest upfront. It depends on the individual loan quote, but as a rule of thumb, with points you break even after year 5. If you keep the loan longer than 5 years, then it saves you money. The tax deduction does not mean much actually. You either have the bigger deduction in the 1st year and then slightly smaller ones afterwards, or regular (slightly bigger) deductions year over year.
Many people nowadays seem to move within 5 years or refinance, so it may not be good for them to buy points.
I personally have bought points in the past and still have these loans. One of them just now reaches the age of 5 years, and it seems such a long time. It is a very good rate though, under 5% and fixed.
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