“Do you want to pay points?” is the kind of mortgage question that leaves many people thinking “I don’t even know what that is!” Here’s a simple explanation.
Points are pre-paid interest. You pay interest now (which is frequently tax-deductible) to lower your long-term rate. “One point” is 1% of the total loan amount.
If your lender is willing, ask to compare a loan package with 0 points to options with 1, 2 or more so you can see the short-term and long-term effect.
As an example and general guideline, on a 30-year mortgage, your interest rate will go down by about 1/8 (0.125) for each point paid — 3% interest would drop to 2.75% with 2 points paid.
If you plan to stay in the home for a while, points can reduce your monthly payment, while the up-front tax deduction might help with first-year finances.
PRO TIP: In some market conditions, negotiating to have the seller pay points may be an option. Talk with your real estate professional and lender.