Study Shows Paying Mortgage Points Rarely Worthwhile

That is the question.

And more often than not, the answer is NO.

A new report claims that borrowers tend to purchase too many points when selecting a mortgage - and in the process end up paying more than they would have with no points and higher mortgage rates.

The study was co-authored by Abdullah Yavas, Professor of Business Administration at Penn State’s Smeal College of Business, and Yan Chang of Freddie Mac, and is reported today by Business Week.

The two considered 3,785 individual mortgages originated from 1996-2003, looking at the points paid, interest rates and the average loan term.

Data showed that those who buy points are overestimating the amount of time they will hold their home loans. They tend to pay off their mortgages about 37.5 months too early for the purchase of points to actually pay off - defaulting, moving or refinancing before hitting a break-even point so the strategy made sense.

• By purchasing points, borrowers lower the rate on the mortgage. One point, or origination fee, is equal to 1 percent of the mortgage, and charged as prepaid interest.
• Points that you pay to purchase your primary residence are deductible in the year you pay them on your federal income-tax return; points you pay to refinance must be written off over the life of your mortgage.

“We underestimate the possibility that we may refinance in the near future - or refinance again in the near future - and the possibility that we may have to move, either for job relocation or other reasons,” Yavas said.

The numbers tell a surprising story. A tiny 1.4 percent of borrowers who purchased points held their first or second mortgage loans enough to make it pay off; of those who didn’t buy points, only 1.5 percent would have been better off purchasing them, according to the study.

However, the researchers are quick to point out that the data covers a time of lower interest rates and increased property values, leading to plenty of refinancing activity.

The report also found that borrowers who buy points often don’t treat them as costs they can never recover and so are less likely to refinance. When they do, they often do it late, perhaps hoping to compensate for the points.

If a borrower went ahead and “paid too many points and the rates come down quickly, refinancing right away would be the same as accepting the fact that you shouldn’t have paid those points,” Yavas said.

Yavas took an interest in the topic after he decided to refinance his own home a few years back and considered the trade-off between points and interest rates. Like mortgage prepayments, this is a subject that is hotly debated, but one for which little research of this caliber has been produced.