What Are Discount and Origination Points on a Mortgage?

Origination

Origination refers to the administrative process required by the lender to originate a mortgage loan. Origination includes receiving and reviewing the loan application, sending the application to underwriting and carrying out the administrative task of closing the loan, which means having the borrower sign all of the necessary documents. Origination costs money because the lender must pay employees or independent contractors to carry out these processes. Origination fees also may cover a certain amount of profit for the lender or mortgage broker on the transaction.

A federal law called the Real Estate Settlement Procedures Act (RESPA) requires mortgage lenders to charge fees only for services that are actually rendered, and the fees charged must be reasonable. Therefore, most mortgage lenders charge an origination fee to closely approximate the lender's actual cost incurred in originating the loan. The cost is often expressed as a percentage of the loan, such as 0.5 percent or one percent. One percent is equal to one point. Therefore, on a $200,000 mortgage loan, one origination point would cost $2000.

A discount point is not designed to cover any of the lenders costs. Instead, discount point allow borrowers to prepay mortgage interest so that the effective interest rate on the loan is lower. In other words, lenders allow borrowers to buy a lower interest rate on their mortgage loan. For example, a borrower may qualify for a 5 percent interest rate. However, if the borrower pays one discount point at closing, the interest rate on the loan becomes 4.75 percent instead. Purchasing one discount point does not necessarily mean that the interest rate on the loan will go down one percent. Instead, you will have to negotiate with the lender to determine the interest rate decrease that will result from purchasing one discount point. One point always equals one percent of the total loan amount, not a one percent decrease in the interest rate.

As with origination points, one discount point equals one percent of the loan amount. Borrowers generally are allowed to pick the amount of discount points that they want to pay, if any. Paying discount points means the borrower must provide more cash at closing, but also means that the monthly payments over the life of the loan will be lower. Buying points may not always be the most beneficial option on a mortgage loan, depending on the total amount of your loan and how long you plan to keep the loan. Generally, the longer you will take to pay off the loan, the more beneficial it is to pay discount points.

Both origination points and discount points are closing costs that the borrower must bring to the mortgage loan closing . This means that the borrower must have cash to cover the amounts owed for origination fees and discount points, which appear on the Settlement Statement as borrower payments. In some cases, though, a borrower may be able to wrap the origination fee into the principal balance on the loan, but, typically, the amount must be presented at the closing.