What Are Origination Points?
Origination is a step-by-step process that every borrower must complete to obtain a mortgage or home loan. Meanwhile, origination points represent the fees borrowers pay to lenders or loan officersto compensate for evaluating, processing, and approving mortgage loans. They represent a way to pay closing costs, and these fees are negotiable among mortgage lenders.
Unlike other types of points (e.g., discount points), origination points are not tax-deductible.
Key Takeaways
- There are two types of points in a mortgage: discount and origination.
- Origination points are fees paid for evaluating, processing, and approving mortgage loans.
- The more discount points paid, the lower the interest rate on the mortgage.
- One point is typically equal to 1% of the mortgage amount.
- Unlike some other mortgage fees, origination points are not tax-deductible.
- It can pay to research andask questions because the number of origination points can vary among lenders.
Discount vs. Origination Points
There are two types of points: discount points and origination points. Discount points represent interest that is prepaid on the loan, and these are tax-deductible. The interest rate will be lower depending on the number of points a borrower pays; the more points paid, the lower the interest rate. Depending on how much a borrower wants to reduce their interest rate, they can pay from zero to four points.
While discount points represent prepaid interest, origination points are the costs the borrower must pay the lender to issue the loan. The cost of the points is tax-deductible if it is used for the mortgage and not for closing costs. According to the IRS, the cost is not tax-deductible if the fee is for items that appear on a settlement statement, such as inspection or notary fees.
Origination points vary from lender to lender, and a single origination point represents 1% of the mortgage loan. For example, if an individual isborrowing $150,000 and the bank is charging the individual1.5 origination points, they will pay$2,250 (or 1.5% of $150,000) in origination points. The fees charged by banks to create the loan are typically 1 origination point, or 1% of the amount being borrowed.
Example of Discount Points to Reduce Payment
Whether a borrower should pay discount points depends on factors such as how much they have to put down as a deposit at closing and how long the borrower intends to stay in the home. If discount points are paid to lower the interest rate, that's an advantage if the borrower plans to stay in the house for a long time because the mortgage payments will be lower. However, in many cases, it is better to pay zero points and use the money for home furnishings or other investments instead.
Let's consider a hypothetical example using a 30-year fixed-rate mortgage from a hypothetical lender (Lender X) to show how paying discount points lowers the interest rate. It assumes that the rate for a 30-year FRM is 4.125%.
| Example Mortgage Rates and Points | ||
|---|---|---|
| Rate | Points | APR |
| 3.875% | 1.524 | 4.075% |
| 4.000% | 0.461 | 4.111% |
| 4.125% | 0.000 | 4.197% |
If an individualborrows$300,000 for anew home, the interest rate can be reduced to 3.875% by paying 1.524 discount points (i.e., $4,572) or4% by paying 0.461 points ($1,383) to the lender. Paying more points will reduce monthly mortgage payments and possibly increase the possibility of having the loan approved.
As for origination points, borrowers should research lenders andinquire about closing costs because they might be able to negotiate the amount paid. Obviously, a borrower wants to minimize the fees, closing costs, and origination points on the mortgage loan.
How Do Origination Points Differ from Discount Points?
Discount points are upfront payments that "buy down" the interest rate on a mortgage, lowering its monthly payments. Origination points are instead used to cover overhead costs for the loan. Origination and discount point fees are both paid at closing. Discount points may be tax-deductible, but origination points are not.
How Much Are Origination Points Usually?
Origination points on residential mortgages tend to be between 0.50% and 1.50%, with 1.00% being the industry average.
How Can I Avoid Paying Origination Points?
Not all lenders charge origination points, so be sure to shop around if this is a concern you have. You might be able to negotiate lower points with your lender to close the deal, or request the seller or one of the brokers involved in the deal to pay them on your behalf.
The Bottom Line
Origination fees might seem like just another closing expense. However, the fees compensate the lender for drawing up the paperwork, verifying the information, and approving the loan. Although you can negotiate the origination points with a lender, you'll be in a stronger position if you have several lenders competing for your mortgage.
Article Sources
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Internal Revenue Service. "Topic No. 504 Home Mortgage Points."
Consumer Financial Protection Bureau. "What Are (Discount) Points and Lender Credits and How Do They Work?"
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