It doesn't make financial sense to pay for points to buy down the cost of a mortgage only to refinance the mortgage before reaping the advantage of the buy down.

Apparently, however, that's what virtually all home buyers do when they elect to include points to lower their interest rate with plans to save money over time, according to "Do Borrowers Make Rational Choices on Points and Refinancing?" a special mortgage study by Abdullah Yavas, an Elliott Professor of Business Administration at Penn State's Smeal College of Business and Freddie Mac analyst Yan Chang.

Only a tiny fraction, 1.4 percent, of borrowers who bought points held their loans long enough to make them pay off. Of those who didn't buy points, only 1.5 percent would have been better off purchasing them, according to the study an examination of 3,785 mortgages originated between 1996 and 2003.

Each "point" is 1 percent of the value of the mortgage. That is, if your mortgage is $200,000, one point is $2,000. Some points are called origination points -- charged for originating or writing your mortgage.

Discount points, the object of the study, are paid to lower your interest rate (and your monthly mortgage payment). The more points you are allowed to elect, the lower your rate. Typically for each point your interest rate slips 0.25 percent.

However, while your rate goes down, you typically carry a slightly larger mortgage balance. One point on the $200,000 loan means you'll be financing $202,000 (plus other typical loan costs and fees).

You can divide the monthly mortgage payment savings -- no-points loan payment minus points loan payment -- into the cost of the points to come up with the number of months it will take to "recover" the points paid at purchase.

Financial education website Motley Fool offers a more exacting "Should I pay points to lower the rate?" calculator to take the guesswork out of the calculation.

Typically most borrowers need five years to recover the cost of the points, which, as it turns out, has been much too long for those who actually choose points, according to the study.

On average, those who purchased points tended to pay off their mortgages about 37.5 months too early for the purchase of points to pay off and hit a break-even point so the strategy made financial sense.

Yavas does concede the data covers a time of decreasing interest rates and increasing property values, which led to a lot of refinancing activity, and swollen equity banks.

Still, given most borrowers move an average of about 7 years (which mean many move much sooner) and given that there is a vast variety of loan programs from which to choose and which otherwise lower the monthly mortgage payment, the value of points warrants close scrutiny.

"Mortgagors face a trade off between paying more points and a lower interest rate. The theoretical prediction is that borrowers with a higher probability of prepayment would opt for a loan with fewer points and higher interest rate. Another theoretical prediction is that once incurred, points become sunk costs, hence should not affect borrowers’ refinancing decisions in the future," the report initially surmised.

It later found, "Utilizing individual mortgage loan data, we find that borrowers overestimate their holding periods and pay too many points. We also find that borrowers fail to treat points as sunk costs; borrowers with points are likely to refinance too late."

Published: December 29, 2006

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Broderick Perkins parlayed a career in old-school journalism into a contemporary digital news service that really hits home. The award-winning consumer journalist, originally from Wilmington, DE, is founder, publisher and executive editor of the bootstrap DeadlineNews Group, a Silicon Valley-based editorial content and consulting service specializing in residential real estate, consumer news and related editorial consulting services. The DeadlineNews Group includes the website, DeadlineNews.com, offering real estate editorial content and consulting services, and its back shop, the Deadline Newsroom, an open house on news that really hits home. Perkins obtained his formal journalism education from University of Delaware and a journalism boot camp, the Institute of Journalism Education at the University of California-Berkeley. He went on to 20 years of service as a daily newspaper journalist at the Wilmington, DE News Journal and San Jose, CA Mercury News. Perkins covered housing on the San Jose Mercury News reporting team which earned a General News Reporting Pulitzer Prize in 1989 for coverage of the Loma Prieta earthquake. He has also produced real estate, consumer and small business content for the Wall Street Journal, Los Angeles Times, RealtyTimes.com, Nolo.com, Better Homes and Gardens, the National Association of Realtors, Homestore/Move and Intuit/Quicken among more than three dozen publications. In addition to managing the DeadlineNews Group, Perkins most recently served as chief editorial consultant for Nolo's Essential Guide To Buying Your First Home, Nolo, and writes real estate television scripts for RealtyTimes.com.