There are several types of closing costs involved when financing or refinancing a home. Some are lender fees while still more are non-lender fees. We’re talking about processing fees, document preparation, title insurance and others. Yet two of these fees alone are expressed as a percentage of the loan amount. Those fees are a 1% origination charge and a 1% discount point. Because they’re both expressed as a percentage, some may mistakenly believe they’re one and the same. But they’re not.
A 1% origination fee is a charge to cover the costs of finding, documenting and processing a loan application. It may be charged by the lender directly or by a mortgage broker. One of the more expensive overhead items in the mortgage industry is actually finding a loan in the first place. It can take years for an experienced loan officer to build a database of referrals and the loan officer can spend quite a bit of funds just getting to that point. Marketing and advertising costs can add up over time and the origination fee helps to offset those costs. The fee is expressed as a percentage of the loan amount and is paid at the settlement table. With a purchase, the origination fee is paid for at the closing table and when refinancing the origination fee is rolled into the final loan amount.
A 1% Discount Point, or a “point,” is also expressed as a percentage of the loan amount but is not used to offset the overhead of running a mortgage operation. Instead, the point is used to lower, or discount, an interest rate on a selected loan. With each type of loan there will be multiple choices on a specific rate. These choices among the rates can vary by 0.125%. The more points the borrowers select to pay, the lower the interest rate on the loan. For example, paying 1.0 point on a $300,000 loans means $3,000 will be collected at the closing table and can typically lower the rate on a 30 year fixed rate loan by about 0.25%.
For example, take a conventional 30 year fixed rate at 3.50%. This rate might be available for no points at all (rates quoted are for illustration purposes only). By paying 1.0 point, or $3,000 on a $300,000 mortgage, the rate could be 0.25% lower. In exchange for paying the point, the consumer is awarded a lower rate. It’s important to note that paying points or not paying points is entirely up to the borrower, the lender really has no preference. Either you pay the lender a point upfront to lower the rate or the lender locks in a no point loan with the higher rate and collects a greater amount of interest over time. When getting your rate quotes, you’ll be presented with various rate-and-point combinations. Whether or not to pay points can be decided by comparing the difference in monthly savings over time and how much the discount point adds up to.
And it’s not always a 1.0 point decision. Point selections can be made at a half-point, or 0.50. Even a quarter point. 2 points means a lower rate compared to a loan selection with no points. There are even “negative” point selections. Just as a consumer can lower a rate by paying 0.25 percent, the consumer can decide to pay a slightly higher rate and receive a lender credit toward closing costs. This scenario is where the term “no closing cost” loan comes from. There are costs involved, it’s just a matter of who pays for them, you or the lender.
When you first apply for a mortgage, I can provide you with a Loan Estimate which will include important details about a mortgage loan including any discount points for your selected rate and an origination fee, if any, along with other loan costs you might expect. After a brief phone call, I can provide you with current rates along with an estimate of these closing costs, including the differences between an origination fee and discount points.