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Hi Edie,

We are trying to buy a house at the very tippy, top of our budget. It was much more affordable when the interest rates on 30 yr fixed in Chicago were below 7% in early April. Does anyone have an opinion about using points to lower the interest rate? If we use points, can we use them in a tax write-off in IL?

First off, all non-recurring closing costs are tax-deductible, including discount points. On a purchase they're deductible the first year, on a refi the deduction is spread over the life of the loan.

Now, regarding whether it makes sense to buy down the rate or not, it's not a simple yes or no answer.

Ray is correct that discount points can be considered pre-paid interest, BUT it's not straight interest. As a basic rule-of-thumb, every cash-dollar you pay into closing will reduce your interest paid on the loan by TEN dollars over a 30 year ammortization.

So the intelligent decision comes down to the questions of
1) how long you intend to stay in the loan,
2) how much cash do you have now to eliminate costs over the long haul,
3) how willing are you to carry what becomes an approximate interest rate of 33% annually on the closing-cash you borrow from the lender (or choose not to pay yourself.) Since $1 paid will get you a $10 interest reduction, OR $1 THEY pay will get you a $10 interest burdon, the effective cost of NOT paying points is 33% per year. (Take the $10 cost on that $1 point, and divide the $10 by 30 years, for 33 cents interest per year.)

NOW... if you're only going to be in your home (or this loan) for less than 7-10 years, it may actually make sense to take the higher interest rate and let the lender pay costs (or you not pay points) as the current value of your cash may be worth the 33% carry cost.

If you expect to be in your home approx. 7-20 years, it becomes a grayer decisiion... maybe it makes more sense to pay in some cash now to get the better rates.

If you'll be dropping anchor for good, and do not foresee moving or refinancing for over 20 years, then it definitely makes great sense to pay the maximum discount points to get the lowest interest rate the lender will allow, as you will reap a much greater reward by recouping that 33% annually on your cash against loan interest.

This is a somewhat complex concept... I hope I did it justice. Feel free to post back with more questions if needed.

Most folks simply shrug off points as "unnecessary costs" and pay through the nose over time when they don't have to. Of course, the lenders KNOW the public looks at it this way, so the game is rigged to favor the banks against the public's ingorance. Be smart, make your decision from awareness!

All the best,
Dave Donhoff
Lic. Mortgage Broker
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