If you pay points, you're paying your lender some of the interest up-front, in a single fee, in exchange for a lower rate. What's the difference in rate if you pay a point? Two points? There is no symbiotic relationship between rates and points, but generally speaking for each 1/2 point, you can drop your rate by 1/8 percent. Paying one point will drop your rate by a quarter percent, and so on. Again, there is no correspondent trade off between points and rates, but usually one point will get you 1/4 percent.
So how do you decide? How do you decide whether or not to pay points? First calculate your monthly payments by paying a point then do run the same routine with paying no points. Let's say you've got a loan amount of $250,000 and you're quoted 7.00 percent with zero points. That's $1,653 per month in principal and interest for a 30-year note. Your lender can also offer a rate reduction of 1/4% for one point. The monthly payment on a $250,000 note at 6.75 percent drops to $1,612, or a difference of $40 per month.
Now divide that $40 monthly savings into that point you paid, or $2,500. The result is the number of months it will take to "recover" the cost of the additional funds to drop your rate. In this case, it would take just more than 62 months, or five years, to recover that money. On the other hand, your lender will make an additional $40 per month at the higher rate in lieu of your up-front $2,500.