Cash method taxpayers must capitalize prepaid interest and deduct it over the life of the loan on which it is paid. This general rule for prepaid interest also applies to “points,” i.e., the additional interest charge paid when a loan is incurred.

Mortgage points, also known as discount points, are fees a homeowner pays directly to the lender (usually a bank) in exchange for a reduced interest rate.  This is sometimes referred to as buying down the rate.

Points are a form of prepaid interest; one point is equal to 1% of a loan amount. Points are often labeled “loan origination fees,” “premium charges,” "buydown fees", etc. At times, certain loan charges may be called points but are really amounts lenders charge for setting up a loan.

Such “service charge points” aren’t normally deductible. The other costs, in excess of the pre-paid interest, are includable in the property’s basis to the extent they were incurred to acquire or substantially improve the mortgaged property. They would not be deductible at all when the property is refinanced for other purposes. This discussion will involve points in the form of prepaid interest not only on home mortgage loans, but also on loans to buy other kinds of real properties.