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Pointless
When the IRS announced that seller-paid "points" on mortgages could be deducted on buyers' tax returns, the news media generally picked up the story. However, the new rule was published on April 11, a date on which many taxpayers were preoccupied with other, more painful concerns.
Since the publication date, there has been little, if any analysis of the true benefits of the rule, though many mortgage lenders have trumpeted the new deal. Missed entirely is the cruel truth: these points can be deducted, but points are still a lousy deal -- no matter who pays them.
Most of the rule change itself has been understood reasonably well, though one course of this free lunch is not quite as free as it looks. Typical of IRS twists, there has to be some accounting for the money paid by the seller to the buyer which the buyer is going to deduct. While this seller-to-buyer payment is not "income," the IRS does consider it to be an adjustment to the cost of the home.
"Cost" in IRSland is related "basis" (Big help there, huh?). Cost or basis are the things you subtract from an eventual sales price to figure your capital gain. For example, if you buy a place for $100,000, and deduct two seller-paid points, your cost basis falls to $98,000. When you sell the home, your taxable capital gain will rise by the amount of the points, and therefore the points will be taxed then.
Still, it's better than no deduction, and it's worth reviewing your records back through 1991 (the date for retroactivity for amending a return). Also, who knows: you may avoid capital gain taxes on your home because of the age 55 waiver.
The part I've not seen in any analysis of this matter is related to a basic rule of taxes: don't spend money just to have a deduction. Your business trip may be deductible, but don't buy more tickets than you are going to use. You may be able to write off most of your lunch with a client, but don't order six meals for two people. If you have size 10 feet, don't buy size 12 shoes just because there's a 33% mark down.
Paying points is not as bad a deal as the shoes, but does resemble the lunch.
The inevitable law of points is a cost of .625% of the loan amount in order to reduce the rate on a fixed rate loan by .125% (one-eighth). Sometimes it's a half point fee (.50%), and rarely as high as three-quarters (.75%). "Origination fees" are exactly the same thing as points, and the law of points applies to them, as well.
On a $100,000 loan, a reduction in rate of one-eighth percent reduces the monthly payment by about nine dollars per month. At .625%, The fee to achieve the reduction is $625. At nine dollars per month, it will take you six years to break even (longer actually, because the $625 is in today's dollars, while nine bucks won't be worth nine bucks six years from now). Break-even always takes that long because that's how long lenders expect the average loan to last.
About now, a shout from the crowd of eager shoppers: "But the points are deductible!" So are the interest payments. Both the $625 and the nine bucks are deductible. Apples to apples, and the break-even is still six years or more.
Another shopper: "But the seller is paying!" There is another useful law of shopping: what else could I get for my money?
What else could I get from the seller? The seller could pay your closing costs, which are neither deductible by you, nor get you a cheaper rate. You could ask for that beautiful refrigerator that the sellers want to take to their new home (or washer, dryer, freezer, chandelier, lawnmower, shelves, carpetÉ.). How about a new roof, or new paint to your taste?
Since builders are the main payers of points, how about upgrades or landscaping, instead? If your employer wants to pay points for you when moving you, ask for a lump sum cash payment (even IBM is moving toward such a system).
One last piece of the points game explains why some lenders are so eager to emphasize deductibility, and are point-pushers in general. If you sell or refinance before the monthly interest savings have recaptured the point expense, you leave points on the lender's table, and the loan yield to the lender is much higher than you bargained for.
For example, if you paid one point to get down to 8.25%, and one year later got transferred out of state, and had to sell, you really paid 9.25% for that first year. When you refinanced last year, did your old lender offer you a refund of the points you paid on the old loan? Not hardly.
The nouveau mortgage slang is "zero and zero:" no points, no origination. Be pointless.
(Though I know a little about finance, nobody should rely on these comments as tax advice. You might get what you paid for.)
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