Mortgage Interest: What Can You Deduct at Tax Time?

· Points. This is money that a borrower pays upfront to the lender, usually to reduce the mortgage interest rate. Generally, one point equals one percent of the loan. So if you borrow $400,000, one point will cost you $4,000. It is likely to reduce your mortgage rate by about one-eighth of a percentage point.

In recent years, points have fallen into disfavor among borrowers. Why pay $4,000 to a lender just to save a few dollars a month on mortgage payments, especially if the additional money paid is probably tax-deductible anyway? We can be too concerned about interest rates. If you do the numbers, you will see that the savings are not really that great.

A $400,000 loan amortized over 30 years at 5.5 percent will cost you $2,271.16 per month in principal and interest. That same loan at 5.375 carries a monthly mortgage of $2,239.90 -- a savings of $31.26 per month. While I do not belittle any savings, no matter how small, the fact is that this is a small amount. And if you are in a 28 percent tax bracket, that reduces the savings to $22.50.

However, points are deductible, again with limits. When you buy a house, the points you pay for your loan are deductible in full when you file your next tax return. If you obtain a refinance loan and pay points, you must deduct them ratably -- equally -- over the life of the loan. In the example above, if your $400,000 loan is for 30 years, each year you can deduct only 1/30 of the $4,000 you paid ($133.33). When you pay off that loan, any unused points are fully deductible. There are several restrictions on deducting points, and you should discuss this with your tax adviser.

· Mortgage insurance premiums. If you put down less than 20 percent when you buy a home, your lender may require you to obtain private mortgage insurance. The Federal Housing Administration and the Department of Veterans Affairs require their own variations on mortgage insurance; the VA calls it a funding fee.

Congress finally recognized what legal scholars have been saying for years: The payment for such insurance is no different from mortgage interest and should also be deductible. If you obtained a home loan in 2008 that included mortgage insurance, you may be able to take a deduction and list it on Line 13 of Schedule A. There is a limit on the amount you can deduct. If your adjusted gross income is more than $109,000 for a single person or married couple filing jointly -- $54,500 if you're married but filing separately -- you cannot deduct these premiums.

The IRS has provided a relatively simple worksheet to assist you in determining this deduction. It's on page A-7 of "2008 Instructions for Schedules A & B, Form 1040." This is also available from the IRS Web site.

Next Saturday: Home sales and capital gains tax.

Benny L. Kass is a Washington lawyer. For a free copy of the booklet "A Guide to Settlement on Your New Home," send a self-addressed stamped envelope to Benny L. Kass, 1050 17th St. NW, Suite 1100, Washington, D.C. 20036. Readers may also send questions to him at that address or contact him through his Web site, http://www.kmklawyers.com.