The concept of "discount points" or "points" can be unfamiliar to a first-time home buyer. And even if you aren't purchasing your first home, you might need a refresher on just what points are and how they work before making a decision about whether to pay them at closing.

What are points?

The simplest definition of points is that they are a type of pre-paid interest on your mortgage loan. Each point is equal in value to one percent of the loan's entire value. So if a loan is for $100,000, each point costs $1,000. Paying points effectively lowers mortgage payments for a home buyer.

Who pays for points, and when?

Points are generally paid by the home buyer at the close of a home sale. Occasionally, depending on the terms of the sale, a buyer may negotiate for the seller to pay some or all of the points. A seller can agree to pay points as an incentive to the buyer to make the purchase.

What are the advantages and drawbacks to paying points?

Paying points at the close of sale reduces the interest a home owner will pay throughout the life of a home loan. This results in lower monthly mortgage payments than with a loan on which points have not been paid. The obvious drawback to paying points is that it results in increased upfront costs at closing – a time when buyers can find themselves faced with other closing costs that can add up.

If a buyer is not planning to stay in a home for a long period of time, paying points might not be a sensible option. Home buyers should make sure they understand when the savings will kick in on a loan on which they have paid points. The briefer the stay in a new home, the less sense it makes to pay points. And if a buyer plans to refinance in the future in order to pay off a loan more quickly, it's important to note that any points already paid on the loan are not refundable.

How do I decide whether paying points is the right option for me?

The decision to pay points requires discussion with your lender about the terms of your loan, its interest rate, and your personal financial circumstances. Make sure that you understand whether the benefits outweigh the disadvantages to paying points and how any points paid with play into your overall closing costs.

While paying points on your loan might make long-term financial sense, it is not mandatory. As with any aspect of your home purchase, educate yourself about your options so that you can determine the best choice for you.

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