Discount Points and Origination Points – A Pointed Discussion

In the real estate world, there’s a lot of talk about discount points and origination points.  Though both a part of closing a real estate loan, their functions are different.  So let’s discuss these pesky customers.

Where to start with points?  There are two definitions: (1) the underlying mathematical definition which applies to anything (real estate or not) that involves percentages, and (2) points as they are used when speaking of loans

• Mathematical: When we say ‘point’, ‘percentage point’ is implied – English has just dropped the word ‘percentage’ off of the phrase.  However – pay attention here… this is the hard part – a point is the same as a percentage point but it is not the same as a percentage. This can be confusing (even to people who should know the difference).  Maybe this will help:

Percent #1: 2%

Percent #2: 8%

Percentage Point, or simply Point, Difference: 6 Points (2 + 6 = 8)

Percentage Difference: 400% (Percent 2 is 4 times bigger than Percent 1, or 400% bigger).

• The second definition of ‘point’ applies to discount points and origination points.

Origination points are fees charged by lenders for processing the loan.  If a buyer has a $300,000 loan and the lender is charging .5% in origination points, the buyer is paying the lender $1,500 for its services (one point on $300,000 would be $3,000, so ½ point would be $1,500).

Discount points, on the other hand, are used to lower (or ‘buy down’) the rate (think of it as pre-paid interest, if that helps).  This reduction in rate can be temporary (e.g. 2 or 3 years), or for the life of the loan. As an example, the buyer pays one discount point and the interest rate is lowered by ¼ of a point.  So, if the loan amount is $400,000 he would pay one point, or $4,000, to lower the interest rate ¼ of a point, say from 6% to 5.75%. 

All points are paid up front before the loan closes.  When a buyer signs paperwork for his loan, he will be asked to bring in a check for a certain amount.  This check will cover all that he owes, including down payment, closing costs (which include the discount and origination points), property taxes, hazard insurance, and any other charges.  So all points are paid at the beginning of the loan.

Bonus Material!  Exciting!

Though less common to see, there is also a ‘basis point’.  A basis point is 1/100^th of one point (or, if you want to really confuse people… a point of a point).  Basis points are commonly mentioned in the world of finance (all finance, not just real estate finance).  As a quick instance, someone might say, ‘the rate just went up 20 basis points’, meaning it went up 2/10 of a percentage point, say from 5.20 to 5.40.