Discount mortgage points (or points, for short) are simply interest you can choose to pay up-front when you get your mortgage. One point equals one percent of your overall loan balance.

By paying some interest up front, you get a lower interest rate for the life of the loan — this is also known as “buying down your rate.” And most of the time, because points are pre-paid interest, you can deduct them from your taxes for the tax year you pay them.

To decide if buying points is worth it for your situation, it’s important to figure out what your break-even point is. In other words, how many years will you need to remain in your home in order for your pre-paid interest to be a worthwhile investment? Don’t worry, it’s a matter of some simple math.

Let’s say you qualify for a mortgage with a 6 percent interest rate and no points (known as a “zero-point rate,” which is simply a base interest rate with no pre-paid interest). You also have the option of paying one point and getting a mortgage with a 5.25 percent interest rate. Which is better?

First, divide the total points by the difference in rate. In the scenario above, that would be 1.00/0.75 (1 point divided by the difference between 6 and 5.25), which equals 1.33. This is how long, in years, it will take to break even from your investment in points.

In other words, it will take 1.33 years (that’s about 1 year, 4 months) to recoup the interest you pre-paid, making the point-investment a wise choice if the you plan to be in your home for more than 1 year, 4 months. At 1 year, 5 months, you’ll be saving money — and that’s regardless of the amount of your home loan.

That wasn’t so hard, was it? Points can be a great way to save money on your mortgage long-term (or not so long-term — it depends on the above break-even math). It does require that you bring more money to the closing table to pay for the points, but in return, you get a lower interest rate for the life of your loan.

[tags]quizzle, mortgage, home loan, discount points, break even[/tags]