What are mortgage points?

One way to lower the interest rate on your mortgage is by putting more money down upfront. Mortgage points are essentially prepaid interest: for each point you buy, your APR is reduced and your monthly mortgage payments decline accordingly.

While mortgage points can be a money-saver for some homebuyers, their value depends on the kind of mortgage you have, how long you expect to live in the house and other factors.

Mortgage points, also called discount points, are fees that borrowers can pay upfront in exchange for a lower interest rate on their home loan. This process is referred to as mortgage buydown or mortgage rate buydown.

Typically, lenders will allow borrowers to purchase as little as a fraction of a single point up to three points.

One mortgage point typically costs 1% of your loan and permanently lower your interest rate by about 0.25%.

If you took out a $200,000 mortgage, for example, one point would cost $2,000 and get you a 0.25% discount on your interest rate. Two mortgage points would cost $4,000 and lower your interest rate by 0.50%.

The cost and discount value of a point can vary, however, so check with your lender.

The largest mortgage provider in the U.S., Rocket Mortgage was ranked number one in J.D. Power 2023 U.S. Mortgage Servicer Satisfaction Study. Rocket offers 30-year fixed, jumbo, VA and FHA loans with two or more discount points available, though borrowers may need to make a larger down payment and have very good credit to qualify.

Bank of America offers points on 15-year, 20-year and 30-year fixed mortgages, as well as on 5-year, 7-year and 10-year year ARMs.

The amount you'll save depends on the size of your loan, how many points you're buying, how much of a reduction they offer and the length of your loan term.

Without points, a $200,000 mortgage with 4.5% interest and a 30-year term results in monthly payments of $1,013.37. If the borrower purchased one mortgage point for $2,000, however, the interest rate would drop to 4.25% and their monthly payment would fall to $983.88.

Over the life of the mortgage, they would enjoy a savings of $10,616.40 in interest payments (or $8,616.40, once you subtract the initial $2,000 spent on points.)

If the same homebuyer bought two points for $4,000, they'd double their savings: The interest rate would drop from 4.50% to 4.0 % and their monthly payment would drop from $1,013.37 to $954.83. Over 30 years, they'd save $21,074.40, (or $17,074.40, when you subtract the initial $4,000 investment).

Mortgage points can save homebuyers a considerable amount in the long term. And the points are typically tax-deductible, though you'll have to itemize your deductions.

Buying points makes the most sense if you plan on staying put for the duration of your mortgage, or at least until you break even on the amount you paid for them.

If you purchased two points upfront on a $200,000 mortgage with a 4.5% interest rate and a 30-year term, you could save $21,074.40, in interest. But it would take 68 months (or five years and eight months) to break even on the $4,000 you spent on those points.

The Mortgage Research Center's online calculator will show you how many months it will take for the points to pay for themselves, as well as what your monthly mortgage payment will be and the net interest you'll save.

If you plan on selling the house within five years, however, it's unlikely you'll recoup the investment.

Points probably also don't make sense if you expect to refinance your mortgage early on, since your current interest rate will go down anyway. And if you have an adjustable-rate mortgage, they'd only be useful during the initial fixed-rate period.

Before buying any points, consider how much available cash you have, since you'll also have to shell out for the down payment, closing costs and other fees before you get the deed. After you move in, you'll also need money for moving, renovations, repairs and unexpected costs.

The cash you might use for mortgage points might be better put toward a larger down payment since you'll immediately get more equity.

At CNBC Select, our mission is to provide our readers with high-quality service journalism and comprehensive consumer advice so they can make informed decisions with their money. Every mortgage review is based on rigorous reporting by our team of expert writers and editors with extensive knowledge of mortgage products. While CNBC Select earns a commission from affiliate partners on many offers and links, we create all our content without input from our commercial team or any outside third parties, and we pride ourselves on our journalistic standards and ethics.

Catch up on CNBC Select's in-depth coverage of credit cards, banking and money, and follow us on TikTok, Facebook, Instagram and Twitter to stay up to date.