Borrowers seldom score by paying points |
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Woodheads and sunk costs
Chang and Yavas uncovered a disturbing tendency of borrowers to hang onto their mortgages too long if they had paid points. Too many consumers don't understand the concept of sunk costs.
A sunk cost is an expense that, once paid, should have no bearing
on future spending decisions. When you pay discount points, you
wave goodbye to your money. If rates plummet a couple of years later,
and you would save money by refinancing, you should do it. That's
the smart move financially, and it doesn't matter whether or not
you paid points.
Human nature being what it is, we don't always do
the financially optimal thing. We exhibit what's called "woodhead"
behavior -- doing irrational things, such as refusing to refinance
even when we would save a lot of money, just because we spent money
on discount points.
"Instead of simply regretting the past and treating the point payments as a sunk cost, they may be delaying their refinancing decisions to make their point choices look better," the researchers write.
Chang says there might be other reasons for procrastinating --
not wanting to disclose financial information on a refinance application,
not having time to apply, or "waiting for a deeper rate reduction,
possibly for points paid previously that had not reaped its full
return." All of these are hard to fit into economic models. The nitty-gritty
Back to the original question: Should you pay discount points? Maybe, if paying points gives you peace of mind and you expect to keep the mortgage past the break-even point.
Just remember that Chang and Yavas say that most people overestimate how long they'll keep the mortgage. As Yavas explains, borrowers "simply have inaccurate or irrational expectations about future interest rates and their chances of moving to a different location (e.g., due to job relocation)."
Don't be a woodhead if you pay discount points and then rates drop enough to warrant refinancing. Go ahead and refinance. Accept the fact that you made the wrong bet by paying points -- you wagered that rates wouldn't fall far, and they did. That doesn't matter. What matters is that you can save money now.
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