Lately, this chimp has seen lots of people purchasing mortgage points, when the vast majority of them probably shouldn’t have. Are you wondering if you should buy points on your mortgage? We think buying mortgage points is generally a bad idea but it can make sense in some scenarios. Let’s break down how to determine what’s best for you.

To start with – what is a mortgage point? Points (or discount points) are essentially prepaid interest on your mortgage. You can purchase points for 1% of your total mortgage amount, to reduce (or “buy down”) the effective interest rate on your mortgage (typically by around .25% per point), thus reducing your monthly payments over the life of the mortgage.

The first thing to consider is how long it will take to “break-even” on purchasing points. For instance, let’s assume you are considering a $300k mortgage with the option to get a 4% interest rate with no points ($1,558 / month) or a 3.5% rate ($1,490 / month) with 2 points. Purchasing the 2 points will cost $6,000 up front, but will save you $68 ($1,558 – $1,490) every month you keep the mortgage. Because $68 / $6,000 is 88.2, it would take 88 months, or almost 7.5 years to recoup the cost of the points. This is the primary disadvantage of purchasing mortgage points – in order for them to be worth the cost, you need to keep your mortgage for a (often very) long time. Although, you may intend to stay in the home for a while, a lot can change over the course of a few years. Even if you do not end up moving, if interest rates fall, it may make sense to refinance, which would also limit the benefits of points.

The second thing to consider is whether you can really afford to purchase points. Because purchasing a home is such a large investment just coming up with the down payment usually consumes a lot of savings. If coming up with more money to pay for the points would eat into your safety fund, it’s probably not a good idea. Also, if you don’t have the full 20% to put down, it’s usually a better idea to put money towards that (so you don’t have to pay PMI) instead of purchasing points. Extending this further, you should think about any other opportunity costs of using the money to purchase points. Is there another investment or use that could have more value for you? e.g., putting more towards your 401k or paying off existing debt?
To sum up, it’s worth considering points if you have the money and are fairly certain you will remain in a home for several years, but we given that the future tends to be relatively uncertain, we generally find it is advisable to pass on purchasing points.