When applying for a mortgage, you’ll hear a lot of terms thrown around, many of which can spark confusion. And “discount points” is no exception.

At first, they may sound like a good deal—after all, who doesn’t want a discount? But deciding whether to buy them can be more complicated in practice. Let’s take a closer look at what they are, how they work, and how to determine if they are a smart move for you.

What are discount points?

Discount points, also called mortgage points, are essentially a way to cover some of the interest on your loan up front in exchange for a lower rate. In other words, you spend more at closing but save money on your monthly payments and reduce your total interest paid over the life of the loan.

In general, you can expect one point to cost 1 percent of your loan amount and reduce your mortgage rate anywhere from 0.125 percent to 0.25 percent. That means if you’re borrowing $300,000 and your starting rate is 7 percent, one point would cost $3,000 and drop you to as low as 6.75 percent. While the specifics can vary from lender to lender, the idea is the same: the more points you buy, the lower your interest rate will be.

Key considerations

The biggest reason homebuyers choose to purchase discount points is to save money in the long run. Continuing the previous example, lowering your interest rate by 0.25 percent to 6.75 percent could reduce your monthly payment by $50. This can bring some welcome relief to your finances and make your mortgage more affordable for years to come. However, make sure to consider your budget at closing. If you have extra funds set aside and want to invest in long-term savings, points can be a good option. But if you’re stretching to cover your down payment and other closing expenses, it may be wise to forgo them instead.

Another important factor to keep in mind is how long you plan to stay in the home. You want to reach your break-even point—when your interest savings have added up to the amount you spent up front. For instance, if you paid $3,000 on a discount point to lower your mortgage payment by $50 a month, it would take sixty months (or five years) to recoup your costs. So if you expect to stay in your home longer than that, you’ll come out ahead. But if you plan to move or refinance in just a few years, you might not see enough savings to make it worthwhile.

The bottom line

Discount points can be a valuable tool to help you lower your mortgage rate and save money over time, but they may not be ideal for every homebuyer. Before you decide, it’s smart to run the numbers, consider your long-term plans, and have a conversation with your lender. With the right information and guidance, you can make a decision that fits your budget and helps you move forward with confidence, bringing you one step closer to getting the keys in hand.