Study Examines Who’s Paying Points - and Why

Pay discount points on a mortgage, and you’re taking a gamble.

Plenty of borrowers lost that wager in recent years, according to the Kitsap Sun and a pair of economists. According to Yan Chang and Abdullah Yavas, who set out to describe consumers’ behavior, say you should think hard before you pay discount points, and if you do, don’t hesitate to refinance.

Chang and Yavas concluded that home loan applicants tend to pay points because they overestimate how long they’ll keep their home loans. 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 point is 1 percent of the loan amount. On a 30-year, fixed-rate loan, one point (which is sometimes called an origination fee) typically reduces the rate by one-quarter of 1 percent.

If you can borrow $200,000 at 6.25 percent with zero points, you could borrow the same amount at 6 percent by paying one point, or $2,000.

That would save $32.33 a month. It would take 62 months (more than five years) to break even - for accumulated monthly savings to total the $2,000 paid upfront.

Of those surveyed who pay points:

• Two-thirds had paid off their home mortgage by June 2005, either because they sold the house, applied for a mortgage refinance or defaulted on the loan. Of those people, 1.4 percent benefited by paying mortgage points.
• One-third still had the original mortgage in June 2005, the cutoff date. Of those people, 16 percent already had benefited from paying points by June 2005, and the percentage probably grew higher as time passed.

To summarize: At least two-thirds of the points payers made the wrong bet. Most of the non-points payers made the right call.

That might sound like a slam-dunk against paying mortgage points. It’s not, because mortgage rates were falling and home values were rising during much of the study period, creating many opportunities for mortgage refinancing.

“Personally, I think that it is a caveat of this study that it covers a period typified by historically low mortgage rates and increasing house prices, which offers borrowers more incentive to refinance than times of rising interest rates, where more borrowers might reap the full benefits of mortgage points,” Chang said.

Chang adds that she’s describing how people act, not prescribing what they should do with their mortgage loan. She says her paper makes the point that “the decision process of the borrowers is more complicated than our model can capture.”

“What we could measure,” she adds, “and what the economic theories use as the basis of analysis, are the monetary incentives - gains or losses in dollar terms - but what we can’t observe are the hidden motives.”

“Some borrowers may consider time spent entertaining their families is more valuable than watching the rise and fall of the rates, and therefore choose to pay points because they wish to lock in on a low rate so they don’t have to spend time watching out for cash out refinancing opportunities.”

Bottom line: Borrowers make choices based on their own needs and goals, and in some cases paying points works in their favor. But be sure this is true in your case before you jump the gun. When in doubt, use a mortgage calculator or talk to a professional.