Can You Buy Points on a Refinance?

Refinancing a mortgage involves replacing an existing home loan with a new one, often to secure a lower interest rate, adjust the loan term, or access home equity. This process aims to improve the borrower’s financial situation. Mortgage points represent a fee paid to a lender, typically in exchange for a reduced interest rate on the loan.

Understanding Mortgage Points

Mortgage points are a form of prepaid interest that borrowers can pay to a lender. These points are categorized into “discount points” and “origination points.” Discount points lower the interest rate on a loan, reducing monthly payments and total interest paid over the loan’s lifetime. Origination points are fees charged by the lender for processing and underwriting the loan, and they do not affect the interest rate. When discussing “buying points” to reduce a rate, the focus is on discount points.

Each mortgage point equals one percent of the total loan amount. For example, on a $200,000 loan, one point would cost $2,000. Lenders determine how much a point reduces the interest rate, with a common reduction between 0.125% and 0.25% per point. Borrowers can purchase whole or fractional points to achieve a desired rate reduction.

Applying Points to a Refinance

It is possible to purchase points when refinancing a mortgage. This process involves incorporating the cost of points into the refinance transaction to secure a lower interest rate on the new loan. The decision to buy points in a refinance context involves choosing how to cover this upfront expense.

One option is to pay for the points out-of-pocket as part of the closing costs, requiring sufficient liquid funds at closing. Alternatively, borrowers can roll the cost of the points into the new loan amount. While this avoids an immediate out-of-pocket expense, it increases the principal balance, meaning interest will be paid on the points themselves over the loan term. This can extend the time it takes to recoup the cost of the points.

Evaluating the Financial Impact

Evaluating the financial impact of buying points on a refinance involves calculating the “break-even point.” This is the specific time, measured in months, when the savings from a lower monthly interest payment offset the initial cost of the points. To determine this, divide the total cost of the points by the monthly savings achieved due to the reduced interest rate. For instance, if points cost $3,000 and save $50 per month, the break-even point is 60 months, or five years.

Several factors influence whether buying points is a financially sound decision. The length of time an individual plans to keep the refinanced mortgage is a primary consideration; if the loan is paid off or refinanced again before the break-even point, the upfront cost of the points may not be recouped. The difference between the interest rate with and without points, along with the total loan amount, also impacts the potential monthly savings and the break-even period.

Regarding tax implications, points paid on a refinanced mortgage are not fully deductible in the year they are paid, unlike points on a home purchase. Instead, these points must be deducted ratably over the life of the loan. For example, on a 30-year loan, the cost of points would be spread out and deducted annually over 30 years. An exception applies if a portion of the refinanced mortgage funds is used for home improvements, allowing a corresponding percentage of points to be deductible in the year paid.

Lenders report mortgage interest, including points, on IRS Form 1098 if the total interest received from an individual is $600 or more. Box 6 of Form 1098 indicates the amount of points paid. Taxpayers can find guidance on deducting home mortgage interest and points in IRS Publication 936. If the refinanced mortgage is paid off early, such as through another refinance or the sale of the home, any remaining undeducted points can be deducted in full in the year the loan ends.