Buying your first home can be a confusing process, and one of the most confusing aspects is financing the home. If you’re not financially savvy some of the terminology used in the mortgage industry can make your head spin.

When my husband and I took our our mortgage, one of the things we needed to learn about was “points.” What is a point? Why would you want to pay points? What are the advantages? The disadvantages?

If you’re shopping for a mortgage and want to know more about points, you’re in luck! You can learn from my experience!

What are Mortgage Points?

There are two different kinds of mortgage points. The first type are loan origination points. These points are basically fees that compensate loan officers. These points don’t benefit the home buyer and should be avoided or minimized if at all possible.

The other kind of mortgage points, discount points, are the points most potential homeowners want to know about. One discount point costs 1% of the amount of the loan, and each discount point reduces the interest rate of the loan.

Basically, if you’re taking out a $100,000 loan, you can pay points at $1,000 each to reduce the interest rate on your mortgage, usually in 0.25% increments. Most lenders cap the amount of points you can pay to 3. Thus, you can reduce your interest rate by about 0.75% if you pay three points (or $3,000 in our example).

The Advantages of Paying Points

Points are very attractive to homeowners who are less worried about the up front cost of their mortgage and more concerned about monthly payments. With lower interest payments, a monthly mortgage payment becomes more affordable for the average family. Paying points up front reduces the monthly cost of the loan.

It’s a good idea to pay for discount points if you want to stay in your house a long time. Over the long term, you will recoup the money you pay up front in the savings you gain from your lower interest rates.

In addition, since a discount point is considered mortgage interest, you can deduct the amount you pay for points on your tax return.

The Disadvantages of Paying Points

If you aren’t planning on staying in your home for a long time, you may be better off just paying the original interest rate. You’ll need to do some calculations to figure out when your monthly interest savings equals the money you would pay up front for those points. The break even point is generally around 5 years. If you plan on staying in your home less time than the time it takes to break even, don’t pay the points.

Also, if you’re struggling to pay for the up front fees associated with buying a home (down payment, inspections, etc), it may not be worth it to pay points. Make sure you have enough money in savings to handle emergencies that could arise from being a homeowner. Your peace of mind is more important than a lower interest rate.

So to answer the question of whether or not you should buy discount points, like most financial decisions, the answer depends on your individual situation. Now, however, you can make an informed decision.

If you have a mortgage, did you pay discount points?

Photo by Andrea_44.