Do Borrowers Make Rational Choices on Points and Refinancing ?

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. 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.” Do Borrowers Make Rational Choices on Points and Refinancing