Home buyers tend to purchase too many points when selecting a mortgage and end up paying more than they would have with no points and a higher interest rate, according to a new research report co-authored by a professor at Penn State's Smeal College of Business.

Abdullah Yavas, Elliott professor of business administration at Smeal, and Yan Chang, senior economist at Freddie Mac, found that home buyers who purchased points, on average, tended to pay off their mortgages about 37.5 months too early. In other words, the average mortgagor with points ended up defaulting, moving, or refinancing more than three years before reaching the break-even point from the purchase of the points.

The researchers examined the points paid, interest rates, and loan length of 3,785 individual mortgages originated from 1996 to 2003.

The results show that home buyers are significantly overestimating the amount of time that they will hold their loans. In fact, Chang and Yavas found that only 1.4 percent of borrowers held their loans long enough to make their decisions to buy points pay off.

Of the borrowers in the sample who did not buy points, the researchers found that only 1.5 percent would have been better off purchasing points. Chang and Yavas also found that borrowers fail to treat points purchased as sunk costs when deciding whether to refinance and, as a result, are less likely to refinance—and when they do, they’re often too late.

Rationally, once interest rates drop enough to make it beneficial to refinance, borrowers should do so, regardless of points paid initially. However, the results show that points previously paid do weigh on the decision, possibly because the borrowers don't want to admit they were wrong to purchase the points in the first place or they are waiting for rates to drop further to compensate for the points paid.

In any case, the consideration of the sunk costs of the points ends up costing borrowers more when refinancing. Other results of the study include:

• Borrowers who are less likely to move or refinance take out mortgages with more points.

• Tax-related incentives do not appear to play a significant role in points selection.

"Having your home fully paid for is little consolation when you lose your job. You still have to put food on the table; gas in the car; pay for medical expenses; and pay the property taxes, home owner’s insurance, maintenance, up-keep, and utilities for your house." ~ Ric Edelman

Home equity accumulates in four ways: the money committed in the original down-payment; any appreciation in the local housing market over time; physical improvements or renovations; and, of course, principal payments on the mortgage itself. Through these four avenues, cash value - or equity - steadily builds up in the property. While seemingly desirable on its face, this accumulation of wealth in the home has three detrimental consequences that are not generally well-understood by most consumers. First, the cash in your home is "buried." Not only is it unavailable in the event of a family emergency, it is vulnerable to loss due to periodic downturns in housing values, fire, or natural disasters such as hurricanes (insurance, where available, may not cover the full market value of your home). Perhaps more critical, cash trapped in property is earning zero interest, year after year. No prudent consumer would put money into a savings account or investment plan that yields no rate of return, but many homeowners do exactly that without a second thought when it comes to their mortgages. Furthermore, as a homeowner pays down the principal on a standard mortgage, he or she is steadily eroding the ability to take annual tax write-offs on the interest payments - which is the biggest tax shelter that most Americans will ever have. Put simply, as your mortgage interest payments decline, a greater percentage of your family's income is exposed to taxation.

So, in addition to foregoing any interest on the accumulated equity, the average consumer also unwittingly takes on greater and greater tax liability as he or she pays down their mortgage. In purely economic terms, this could be called "irrational" behavior; but it has been the predominant approach taken by U.S. homeowners for more than 70 years. Historians trace the cause to the Great Depression, when unregulated lending practices triggered millions of loan defaults and foreclosures. The legacy of those times lives on today in the impulse felt by most mortgage holders to pay down their loans as quickly as possible so they can own their properties "free and clear." In doing so, however, they are opting not to take advantage of overhauls in consumer protection laws, financial regulations, and government tax codes specifically designed to help homeowners generate and protect personal wealth.

In short, the range of mortgages available today – coupled with the growth and importance of investing into tax exempt college savings plans or tax deferred retirement savings plans – opens unprecedented equity investment opportunities for responsible homeowners who are committed to planning for their families' security, their children's education and their own retirements. But most Americans fail to explore the power of "working equity."

"The key is not to die with no mortgage but to live the lifestyle you want in financial security and comfort." ~ Ric Edelman

If You Are Buying a Home:

 Generally, the greater your income and assets . and the higher your credit rating – the more mortgage options there are available to you. You potentially could be approved for a bigger mortgage and put less money down. A smaller down payment creates immediate liquidity for investment and preserves the greatest possible income tax deductions on mortgage interest. Put differently, instead of investing your cash in idle principal, you can be investing it in tax-free or tax-deferred interest-bearing funds whose rate of return could potentially outpace the interest rate paid on your mortgage, enabling you to effectively out earn your debt. In fact, some loan programs available today allow you to put down as little as 3.5%. If You Own a Home: If you already have substantial equity in your home, it can be accessed through a "cash-out refinance" mortgage. It's important to consult with a qualified tax professional prior to pursuing this type of loa  strategy to ensure that the interest payments are in fact deductible and to what extent. It's important to understand that there are four steps to financial security and they should be followed in the specific order listed:

There is no one-size-fits-all approach to equity extraction and management. But if done wisely, a world of long-term financial gains can be realized. achve

y It's important to consult with a qualified tax professional prior to pursuing this type of loan strategy to ensure that the interest payments are in fact deductible and to what extent.