One of the perks of home ownership is writing off mortgage interest on your taxes. If you prepay some of the interest when you close, you can write off that money -- known as points or loan origination fees -- as well. You may not be able to deduct them immediately, however, and some loan origination fees aren't deductible at all.
Types of Points
Loan origination fees come in two flavors. Some lenders use the term for closing costs such as appraisal fees, title fees, legal expenses and prepaid property taxes, none of which is deductible. You only get a deduction when the fees -- also called maximum loan charges or discount points -- represent prepaid interest. If the seller pays some of the interest as a condition of the sale, you'll be pleased to know you can claim a deduction for the points she paid.
Even if your fees are deductible, you may not be able to write them off immediately. To write off the points the same year you close, you must be obtaining the mortgage to buy or build your primary residence, using the house as collateral. Prepaying interest must be a standard practice in your area, and the amount you pay must be no higher than normal. If the lender rolls the points into the mortgage to pay off later, you can't deduct them right away.
Points you can't deduct this year have to be written off over the life of the loan. Suppose you pay $7,200 in deductible loan origination fees on a 30-year loan. To figure your annual deduction, divide up the points by the 360 monthly payments, which gives you $20 per payment. When you make 12 payments in a year, you get to write off $240 of loan origination fees. Even if you qualify to deduct the points in the first year, you can choose to pay over time if that works better for you financially.
Your lender may charge you for both deductible and non-deductible loan origination fees. The settlement statement you get at closing should clearly identify the prepaid interest so you can sort out the two types of fees. If you pay more points than is typical in your area, you can write off the typical level this year, and then claim the rest over time. When you refinance, you normally have to claim points over the life of the loan, but the IRS makes an exception if you use some of the money to improve your house.
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