Q: You said that both discount points and origination fees are deductible to the buyer, regardless of who pays them? What’s the difference between them?

A: Technically, the loan origination fee is an amount of money charged by the lender to compensate them for gathering all the data needed to formulate and fill out your loan application, then verify that information, then submit it to the loan underwriter in compliance with secondary market guidelines. In contrast, a loan discount point is a sum equal to one percent of the amount being borrowed, and is a "prepaid interest" fee charged to lower the stated interest rate on the note. Points were seen most frequently when interest rates were extremely high in the 1980's.

Several years ago, the IRS announced that loan origination fees would be considered deductible as points if the amount was stated as a percentage of the loan on the settlement statement. Since then almost all lenders state their origination fee as some percentage of the loan.

Thus, to the IRS, loan origination fees are considered to be points, which makes them tax deductible to the purchaser of a principal residence.

Q: You also said that any "prepaid interest" shown on the purchasers settlement statement is tax deductible. Please explain.

A: While rent is paid in advance, interest is typically paid in arrears. In other words, you usually get the use of the money before you have to pay for it. So your monthly loan payment due on the first of each month consists of interest for the prior month, plus an amount of principal repayment.

Because most loan payments are due on the first, an exception to the above rule usually occurs at the loan closing. If your loan closing occurred today, on the twenty-third of April, no monthly payment is due on the first of May. Instead, the lender charges a daily interest charge for the day of closing and each of the seven days remaining in April. And your first full mortgage payment would be due on the first of June.

The total of the daily interest charges is called "prepaid interest," and is fully tax deductible to the home buyer. However, it can be overlooked by tax payers because it is sometimes not reported by lenders. If your closing occurs in the early part of the month, this charge can amount to a lot of money.

Q: I don’t currently itemize my deductions on my tax return, but I think that if I bought a house, I could start. How can I accurately estimate the tax savings I will experience when I buy my first house?

A: This is a difficult question to answer, because it depends on your personal financial situation.

If you are very close to itemizing and only need a few dollars of deductible items to make itemizing worthwhile, then you will receive almost all of the benefit of the deductions coming from your house.

However, if you have little in the way of deductible expenses now, you are getting a pretty good deal with the standard deduction. Some portion of your housing expense deduction will likely be lost as you climb to the point where you have overcome your current standard deduction.

For these reasons, I strongly recommend that you make the effort to have a tax projection performed by your CPA or tax professional. Once you begin itemizing, it becomes easier to project the savings from future purchases.

Q: I got lost when you started talking about acquisition indebtedness. What does that mean and why is it limited to one million dollars?

A: For income tax purposes, "acquisition debt" is the term the IRS uses to describe debt that you used to purchase your principal residence and/or secondary residence. As you pay the debt off over the years, your "acquisition debt" balance declines, and can not be increased by refinancing or adding loans to your house. Technically, the interest you pay on any amount over your current level of acquisition debt is not tax deductible.

The theory here is that the deduction is to buy the house, not to finance a car or a trip around the world after you own your home free and clear.

Q: But then you talked about a Home Equity Line of Credit (HELOC), and said that interest charged on any HELOC debt of up to $100,000 is always deductible. How can that be?

A: Congress decided to sweeten the deal just a little bit with home equity loans. Even if you paid cash for your house, you could deduct the interest on up to $100,000 of any debt secured by your residence simply be referring to it as home equity debt. This exception to the acquisition indebtedness rule allows for tax advantaged debt shifting of personal debt to deductible debt.

Next week: Questions about tax savings when selling