You see it whenever you check mortgage rates: “zero points,” “1 point,” “2 points.” What’s the point of those points?

Points, also known as “discount points” or “prepaid interest,” reduce the interest rate of your mortgage—and thus, your monthly mortgage payments.

Getting to the points: what exactly are they?

The idea is pretty simple:

  • Every point you pay reduces your interest rate by .25%
  • Each point costs one percent of your mortgage principal (the amount you’re borrowing). So one point on a $200,000 mortgage equals $2,000 in additional up-front costs
  • You pay points as a one-time fee at closing

Basically, you’re paying a chunk of your interest NOW, instead of spreading it over the many years of your mortgage term. As with any financial decision, there are pros and cons:

The Pros of Points:

Lower monthly payments. By reducing your interest rate, you pay less interest over the term of your loan—which means lower monthly payments.

A nice tax break (just once, though). You can deduct mortgage interest on your federal income tax, and that includes points. The deduction is applicable to the tax year in which you purchase the home.

The Cons of Points:

Higher costs at closing. If you’re considering points, double-check your budget and savings to make sure you can afford the higher closing costs. (Something for first-timers to consider: from paint to pillows, the costs of moving in to your new digs can add up fast. Make sure points don’t deplete too much of your savings.)

It’s a long-term thing. Whether you’re choosing a fixed-rate mortgage or adjustable-rate mortgage (ARM), you need to stay in your house several years for the amount you pay in points to break even with the money you save each month. So, if you’re buying a starter home that you expect to outgrow in 2 to 3 years, then points don’t really work to your advantage.

Reduced mortgage interest deduction after the first year. Simple math: points reduce your mortgage interest rate, which means you’ll pay less interest each year. THAT means you’ll have less interest to deduct from your federal income taxes after the year you close on your home.

Do the math to figure out if points will work for you. (We can help, too.)

Use Pen Air’s fixed rate mortgage calculator to compute the difference points can make in your home financing plan (just reduce the interest rate .25 percent for every point purchased). You can also feel free to bring all your real estate questions to Pen Air’s mortgage specialists.

Fixed Rate Mortgage Calculator