Article by R. Joseph Ritter, Jr. CFP® EA
Points on a mortgage are essentially pre-paid interest that is paid to the lender in exchange for a slightly lower interest rate. You may see points used in an advertisement for a particular interest rate. For example, 5.15% with 2 points as opposed to 5.5% with no points. Whether paying points is favorable to you is determined by how long it will take to recover your pre-paid interest. The loan officer or mortgage broker working on your mortgage can calculate this scenario for you if you ask them. The savings on your monthly payment will take much longer to add up to the initial expense when the difference in the interest rate is less. If it takes more than 2 or 3 years to recover your initial outlay, serious consideration should be given to paying points. You may instead be better off investing or applying toward principal the couple thousand dollars you would have otherwise paid in points and elect to take the slightly higher interest rate.