Borrowers seldom score by paying points

Borrowers seldom score by paying points
By Holden Lewis • Bankrate.com


Pay discount points on a mortgage, and you take a gamble. Plenty of borrowers lost that wager in recent years, according to a pair of economists.
Yan Chang and Abdullah Yavas set out to describe consumers' behavior, not to give advice about whether one should pay discount points. Even so, their research can be boiled down to this: Think hard before you pay discount points, and if you do, don't hesitate to refinance.
The studyTheir research paper, titled, "Do Borrowers Make Rational Choices on Points and Refinancing?" is a chapter of Chang's doctoral thesis at Penn State University. Chang is a senior economist at mortgage-financing giant Freddie Mac, but the study was done independently of her employer, and she speaks for herself and not on behalf of Freddie Mac. Yavas is an economist and a professor of business administration at Penn State and was her thesis adviser.
Chang and Yavas concluded that borrowers tend to pay too many points because they overestimate how long they'll keep the mortgage. Furthermore, people who pay discount points tend to wait too long to refinance.
Paying discount points is a way of reducing the mortgage's interest rate. One discount point is 1 percent of the loan amount. On a 30-year, fixed-rate mortgage, one point typically reduces the rate by one-quarter of 1 percent. By this rule of thumb, if you can borrow $200,000 at a rate of 6.25 percent with zero points, you can borrow the same amount at a rate of 6 percent by paying one point, or $2,000.
In the above situation, you save $32.33 a month by paying one point. It takes 62 months to break even -- for the accumulated monthly savings to total the $2,000 paid upfront.
8-year studyChang and Yavas looked at a sample of 3,899 mortgages that were originated between January 1996 and December 2003. About one-eighth of those borrowers paid discount points.
Of those who paid points:
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Two-thirds had paid off the mortgage by June 2005, either because they sold the house, refinanced or defaulted on the loan. Of those people, 1.4 percent had benefited by paying points.
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The other one-third of the points payers still had the original mortgage in June 2005, the cutoff date for the study. Of those people, 16 percent already had benefited from paying points by June 2005, and the percentage probably grew higher as time passed. That doesn't change the fact that two-thirds of the points payers made the wrong bet.
Of the seven-eighths of the borrowers who did not pay discount points, a large majority made the right call.