When buying your first house, the terms and conditions of the mortgage process can be confusing. Here’s a primer on two such terms: points and the origination fee.
Origination fee. This is the cost that the mortgage company charges you for borrowing money. When you take out a mortgage, it is a new loan in what is known as the primary mortgage market. The company loaning you the money is said to be “originating” the loan. It makes its money on charging this origination fee to borrowers like you.
Sometimes the origination fee is figured as a “point.” A point is one percentage point of the loan amount. On a $100,000 loan, one point equals $1,000. The lender may express its origination fee in terms of points, such as an origination fee of one or two points.
Discount points. There is another way points may be charged. The lender may offer you a loan at an interest rate of, say, 3.5 percent, but give you the option to buy down the rate by paying a point or some fraction of a point, at closing. This is known as a discount point. Essentially, you are prepaying some interest to get a lower interest rate over the life of the loan.
Does it make sense to do that? It depends on how much money you have available for closing costs and how long you think you will stay in the house to be able to recapture it. Say you paid that $1,000 point upfront and it results in a $40 reduction in your monthly payment. It would take 25 months to recover your $1,000 paid at closing (25 months X $40 = $1,000). So, just over two years is your break-even point. Do you intend to stay in the house that long or longer? Then it makes sense.
Are points and origination fees tax deductible? Mortgage interest paid is tax deductible, so since prepaid points are a form of interest, they are deductible. The mortgage must be secured by the house as your primary residence, paying points must be a common practice in your area and the amount of the points are consistent with your area. You cannot have used borrowed money to pay the points. There are some other qualifiers that your tax professional can walk you through.
Origination fees figured as points of the loan amount are tax deductible if they are used to acquire the mortgage and not to cover sundry other fees that normally would be broken out separately on the closing settlement statement. Have your professional tax preparer analyze your specific situation.