While shopping around for the right home mortgage, you may come across an unfamiliar term: mortgage points. What exactly are they — and are they worth the added initial cost for the long-term savings?

Mortgage points, also called discount points, are an optional, one-time fee you pay to your lender at closing in exchange for locking in a lower mortgage interest rate.

Purchasing mortgage points may not be the right decision for every homebuyer. However, it’s worth considering because a lower interest rate over the life of the home loan reduces monthly mortgage payments and how much you’ll pay toward interest.

How do mortgage points work?

Typically, one mortgage point costs 1% of the mortgage loan amount, potentially reducing the interest rate by as much as 0.25%.

Mortgage points vary by lender and the specific home loan. Many lenders allow borrowers to purchase less than one point.

To understand how mortgage points work, let’s say you have a 30-year fixed rate mortgage worth $200,000. Two points add $4,000 to your closing costs. If your available interest rate starts at 4.5%, adding two points lowers your interest rate to 4% — saving you about $60 each month, or $720 per year. Over the full term of the loan, this would save you more than $21,000 in interest.

While comparing interest rates, keep in mind that some lenders advertise home loan interest rates based on the condition that borrowers must purchase mortgage points.

Should I purchase mortgage points?

Homebuyers often purchase mortgage points if they plan to live in their new home for several years.

Many financial experts recommend homebuyers find their break-even point before they purchase mortgage points. For a $200,000 fixed rate mortgage, the homebuyer will recoup their investment in about five and a half years.

You can calculate your break-even point using online mortgage calculator tools or by dividing the cost of the points by your annual savings. Results vary, depending on the amount and length of the home loan, down payment and of course, interest rate.

Some homebuyers decline mortgage points because of the additional out-of-pocket closing costs, or they anticipate refinancing within a few years as interest rates drop. Others simply prefer to put the additional money they would pay toward their down payment.

As you consider your financial situation, make sure to explore all of your mortgage options, ask potential lenders plenty of questions and choose a lending solution that best serves your financial needs.

Discover more about mortgage loan offers from First Merchants Bank. Contact us today at 1.800.205.3464 for a free consultation!