Mortgage Refinancing - How Many Points Should I Add?

Should you use points to lower your mortgage interest rate? The answer is a resounding "maybe." A few important factors need to be considered first.

Mortgage Refinance Points Up Front?

Determine how much extra cost you can handle for the closing of your refinanced mortgage loan. Every extra point equals one percent of the loan amount; adding points can be expensive when you're about to sign on the dotted line.

One option is to borrow extra funds to cover the cost of your points. If you go down this road, you'll pay interest on the points that were rolled into the loan balance. It's a bit counterproductive, so you may not save much over the option in which you don't take extra points.

How Long Will You Stay?

Examine how much lower your monthly payments will be when you add points. The longer you plan to keep your new loan, the more it makes sense to add points to lower the interest rate.

Let's say you take four points for a cost of $4,000 in prepaid interest points on your $100,000 mortgage refinance, and this lowers the loan rate from 7.5 percent to 7 percent. The lower interest will save you $60.50 a month. It will take 66 months, or 5½ years, for those savings to make up for the original cost of the points.

If you're planning to stay in your house for only five years-or thinking about refinancing again in that time-four points would be too much for you. On the other hand, if you expect to keep this loan for six years or more, the points will save you money in the long run.

Tax Effects, Points, Refinancing

Some points are not tax deductible because they represent payment for lender services. However, the "prepaid interest" points that lower your interest rate can be deducted. When you add points to an original mortgage, the entire cost of the points can be deducted in one year.

Refinancing points work a bit differently.

Tax Effects, Points, Cash-Out Refinancing

If you take cash out with your refinancing, and then use some or all of those funds for home improvement, you can deduct a proportional part of your points in that tax year. If your old loan has a balance of $80,000, and you refinance into a $100,000 loan, and then use the entire $20,000 of extra cash to build a new patio, you can deduct 20 percent of your prepaid interest immediately.

Taxes don't change your closing costs or monthly payments; but they do have an effect on your tax return. Therefore, they're worth keeping in mind.

Mortgage points aren't right for everyone. However, if you're ready to settle down for the long haul, they can save you a lot of money.

That's a point well taken.