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Let's say I typically make $120K salary every year. And the rest of the income is in long term stock growth (which are not included in taxable income).

But let's say this year I have a income of $360K salary which is three times the income. If I am starting a home loan this year, will it help my tax situation to buy as many points as the loan permits so that I can claim higher tax deductions?

Assume that I go back to $120K next year.

  • Related (potentially duplicate): money.stackexchange.com/questions/2353/…, although it doesn't explicitly address the case where one year has much higher income. – yoozer8 Oct 26 at 13:17
  • If this is the USA, the first thing you should do with any windfall is pay down the mortgage to the point where you eliminate the mortgage insurance - this dwarfs every other consideration. – Fattie Oct 26 at 13:22
  • @Fattie - keep in mind, this related issue . Just paying off that amount does not automatically remove PMI. But, your advice, seeking to remove it, is 100% accurate. The cost is so high, funding the extra 5-10% to get to 20% down from a credit card would actually pay off in the end. – JTP - Apologise to Monica Oct 27 at 14:13
  • quite so, @JTP-ApologisetoMonica – Fattie Oct 27 at 15:37
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The general consensus on paying points to lower your mortgage interest rate is that it's a bad idea. The reason is that it takes a while to break even, say 5-10 years before it was worth it to do so. If you refinance or sell before the break even point then the purchase of points was wasted. If you start overpaying the mortgage to pay it down early, this pushes the break even date out even further. If you're fairly certain you won't sell, refinance, or pay down the mortgage early before the break even point, then paying points might make sense.

Note if you can deduct the points, it doesn't mean that you should, but it does mean that the price of the points is cheaper, and you can use the adjusted price of the points to calculate the new break even date, which should be sooner than if you cannot deduct the points.

Given that you have decided to buy down your rate by purchasing some amount of points, if you can control the tax year when the purchase occurs (say end of December vs beginning of January), then yes, it would make sense to complete the purchase in a year that you know you will be itemizing your tax deductions, and if you're itemizing in both years, then choose the year that you are in a higher tax bracket.

Side note: you can only fully deduct points for a new mortgage (or for home improvements). You can not fully deduct points paid for a refinance- those most be spread out over the life of the loan.

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Doing something solely "so that I can claim a higher tax deduction" is generally not a good idea. While a tax deduction is an usually incentive to do something, you should only do that thing (e.g. donate money, pay mortgage interest/points, etc.) if you were inclined to do so anyway.

Generally, in order to take a deduction of $X, you must give away/spend/lose that $X (capital loss, buying mortgage points, charitable donation, etc.). This results in you having $X less money, but only paying tax on $X less than you would have otherwise (deductions reduce your taxable income not your total tax). The alternative is you don't do the deductible thing, keep the $X, and are liable for a bit more tax. So depending on your marginal tax rate (for your listed income, it is either 32% or 35% for 2020, depending on your filing status), you end up with approximately $1.7X more money if you don't do the thing just for the deduction. This is (other income - X) compared to (other income + X - tax).

Buying points solely for the tax deduction is probably not worth it; you should only do this if you would be inclined to buy the points even without the deduction (or if it's a close decision and the tax deduction is a point in favor of doing so). See Should I pay points on my mortgage?.

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The borrower doesn't buy points on a mortgage; the borrower pays points (effectively pre-paying extra interest) in order to get a reduced interest rate on a fixed-rate mortgage. Pay the points if you are planning on staying in the house for a long time (the reduced interest rate is beneficial in the long term), but negotiate for no points if you expect to move to a different house in a few years. You will pay a higher interest rate (more tax deductions since that seems to be your major goal) but it will be only for a few years. A long time ago, I read that the average duration of a mortgage was about seven years, which doesn't necessarily mean a peripatetic bunch of homeowners, refinancing also terminates the current mortgage and replaces it with a new one.

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