When you search for a mortgage you will hear the term “points” included in the terms and rates for mortgages. But most people only have a vague idea what that means.

When lenders talk about mortgage points, they are actually referring to discount points. Each point is equivalent to one percent of the mortgage loan amount.  For example, on a $250,000 mortgage one point is $2,500.

When you “purchase” points, you are actually prepaying part of your mortgage interest. For every point you pay, your bank or mortgage lender will lower your interest rate.  The amount of the decrease can vary, but it usually amounts to about a quarter of a percentage point per discount point purchased.

For example, if you borrowed $100,000 and bought two points, it would cost you $2,000 and your rate would drop by half a point.  Most lenders offer up to three or four points.

Obviously you want the lowest rate possible, but should you automatically buy all the discount points you can? Before you do that, there are a couple things you need to consider.

First, are you able to afford to purchase points?  Or would you be better off allocating this money for something else. In other words, is buying points the best possible use of this cash? Most people are already stretching their cash pretty thin when they buy a new home.  You’ll have expenses to pay, such as the down payment, closing costs, and moving expenses.  And you may need to do some work on the house to make it to your liking.  Those points could pay for some painting, landscaping, furniture or other projects.

Even if you have the extra cash and don’t want to put it toward the down payment or home improvement projects, you may be able to get a better interest rate elsewhere.  Consider this – If you bought two points on a $400,000 it would cost you $8,000. If you invested that money in CDs, stocks or bond funds, you would likely earn more than you would save by buying points.

You also need to consider how long you expect to stay in this home. The longer you expect to live in this home, the better deal points are.

Buying discount points is simply a way to prepay part of your mortgage loan interest costs upfront.  Since you pay in the beginning, the lender comes out ahead for the first few years.  But your monthly savings in the long run eventually exceed the amount you paid upfront, and you end up the winner.

So the key is to calculate the breakeven point for your particular plans and circumstances.  If you sell your home before the breakeven point, the bank wins. If you sell it after, you win.

How long it takes to reach the breakeven point depends on your interest rate and the amount you pay in points, but for most mortgage loans it occurs between five and six years. You should use a mortgage calculator or ask your lender to calculate the numbers for you so you can determine whether it makes sense for you.