If you’re preparing to take out a mortgage to pay for your first home, firstly…congratulations! This is a huge step, and you should be proud of yourself.
Secondly, make sure you factor closing costs into your budget, and prepare for the headaches that are origination fees and discount points.
To answer your question as bluntly as possible, no, origination fees are not the same as discount points, but you wouldn’t be the first person to puzzle over the two terms.
Most of the confusion is caused by the fact that lenders and lending literature will often also refer to origination fees as “points”. I know, I know…it makes an already complex matter that little be harder to grasp, but after a read of this brief article, you’ll be fully informed on the matter.
Unfortunately, it’s not enough to simply know that origination fees and discount points are mutually exclusive.
These loan parameters can differ significantly from lender to lender, which means you also need to understand what they are in order to determine which lender is right for you.
So, without further ado, let’s grab the bull by the horns and look over some definitions for these terms.
You can think of origination fees like the transaction fee imposed by an online payment portal such as PayPal when you use their service to transfer funds online.
It’s simply the sum charged by the lender (or loan facilitator) that covers their efforts in making it all happen; it’s their commission.
These fees are not derived from any sort of shifting market rate; they are decided upon by the lenders themselves, which is why it pays to shop around for the best estimate.
Origination fees will either be given as a flat rate or expressed as a point(s) that refer to a percentage (usually 1%) of the overall borrowed sum.
For example, let’s say you borrowed $200,000. If you see a $2000 origination fee on your documentation, it means the lender has set the fee as 1 point.
Four points (or 4%) is typically seen as the ceiling charge for origination fees, as anything beyond that is venturing into loan shark territory and considered predatory lending.
Bear in mind that these are not junk fees, you’ll be notified of the origination fee before you sign anything, so they won’t come as an unpleasant surprise…just unpleasant in general.
You’ll be expected to pay the agreed-upon sum after the loan has been approved, and the money is on its way to your account.
It can be irritating forking out more money on top of what is likely the largest purchase you’ve ever made, but oftentimes, loan originators work for commission exclusively, meaning they don’t receive a wage or salary. It’s only fair that they’re compensated for their work.
Should you be a little light of pocket when the origination fee needs to be paid, you can sometimes roll it onto the loan itself (along with many other closing costs).
In this scenario, you wouldn’t have to pay the money up-front, but as part of the loan, it will incur interest, meaning you’ll be paying quite a bit more in the long run.
You may stumble across the odd lender here and there that doesn’t charge an origination fee at all — awesome, right? Well, sometimes, but it pays to be suspicious in these circumstances.
Lenders don’t normally operate out of the goodness of their heart; they’re running a business, which means they’re likely recuperating the loss of origination fees in some other way, with higher interest rates being the usual suspect.
As a rule, always ask for a detailed breakdown of what you’re being charged in terms of closing fees.
Although they sound similar to origination fees, discount points are an entirely different financial entity.
Discount points are options offered to you before the loan agreement is finalized. The more you buy, the lower the interest rate of the loan becomes.
A single discount point almost always costs 1% of the amount you wish to borrow, and will typically reduce the interest rate by 0.25 – 4%, depending on the state of the market.
So, let’s say you’re borrowing $500,000 with a 4% interest rate over a 30-year term, and you pay for two discount points rated for a 1% reduction in interest. It will cost you $10,000, but it will bring your interest rate down to 2%.
As is the case with origination fees, the parameters of discount points fluctuate from lender to lender, so once again, it really pays to shop around for the best deal.
Purchasing discount points is similar to forking out a larger deposit in that both actions bring down your monthly repayments, but discount points are sometimes tax-deductible and bring down the interest rate rather than the borrowed amount.
Choosing whether to invest in discount points or simply pay a bigger down payment is one of the most important decisions you’ll make as a borrower.
Each has its benefits and drawbacks. My advice is to use loan calculators, amortization tables, and consult a professional to assess which would be the best move for you and your loan.
If you don’t think you’ll explore refinancing options and plan on staying put in your new home for some time, discount points may be a worthy investment.
To make discount points work for you, the savings you stand to make on interest need to exceed the price you paid for the points, and this can only happen over time.
Are you expecting to move on relatively quickly? Then you’re almost certainly better off making a more substantial down payment.
Considering both terms typically work on a 1% point system, it’s easy to get loan origination fees and discount points confused, but the long and short of it is that they’re very different things.
Origination fees are the commission earned by the person responsible for acquiring the loan, whereas discounts can be purchased by you to lower the interest rate of the borrowed amount.
Now you can negotiate loan terms with confidence, and snag yourself the best possible deal. Best of luck!