Should You Buy Points or Not?

Make sure you understand what points are. Points (or discount points) are simply pre-paid interest. One point amounts to 1% of the total mortgage. If you have a $100,000 mortgage, one point costs $1,000. That’s pretty much all there is to it.

So why would anyone want to "pre-pay" interest?

You pre-pay interest to get a lower interest rate for the life of your loan. And because points are pre-paid interest, you can, in most cases, deduct them from your taxes in the year you pay the points. That’s a nice one-time tax benefit!

To find out if buying points will pay off for your situation, here’s some simple math you can do:

Let’s assume you are considering two options on the day you want to lock your mortgage interest rate:

a 5.25% mortgage interest rate that costs you one point.
a 6% mortgage interest rate that costs you zero points.

In this scenario, you would pay 0.75% (3/4 of 1%) less interest on your mortgage each year with the 5.25% option. To get this rate, you have to buy one point upfront. Divide the total points paid (one, in the example here) by the difference in rate (0.75) which, in this example equals 1.33 (one divided by 0.75). This is the number of years it will take you to break even from your investment in points. In months, this would be 16.

So, it would take you 16 months to recoup your pre-paid interest money (regardless of your mortgage amount – it’s the same whether you have a $100,000 or a $250,000 mortgage) and from then on you would enjoy your low 5.25% for the duration of your remaining mortgage. If you think you will be in your home more than 16 months, you’re saving money from that point forward.