What is a Loan Discount Fee?

Buying a new home is often a learning process, especially if you are a first-time homebuyer. As you get further into the loan application process, you may come across the opportunity to purchase loan discount points or fees. While your goal right now is likely to hold on to as much money as you can, there are some advantages to paying this fee. Knowing how and why a discount fee can be beneficial helps you decide if it is worth it for your long-term financial goals.

Loan Discount Fee - What is It?

How Do Discount Fees Work?

The easiest way to look at discount points is that they are a fee that you pay the lender to lower the interest rate on your home loan. Each point that you purchase will cost you 1% of your mortgage amount. For example, if you are taking out a $200,000 mortgage, one point will cost you $2,000.

One way to look at this is to think of buying points as paying some of the interest upfront, rather than over the course of the loan. You can choose to purchase multiple points or a fraction of a point. How many you purchase will depend upon how much you want to lower the interest rate.

What Are the Benefits?

Buying discount points lowers your interest rate on the loan. This will make your monthly house payments more affordable. You will pay a little more now to save larger amounts of money down the road.

The amount of savings that you get on the interest rate varies with each lender. On average, you can expect to see the rate lower by about .25% for each point that you purchase. Keep in mind that most lenders place a cap on how many points you can purchase. Usually, you can buy anywhere between one to three points. The idea is to save on interest, but you can’t eliminate it entirely.

There may also be potential tax benefits if you choose to purchase points. Loan discount fee payments are considered to be prepaid mortgage interest. Depending upon your tax-filing status and financial standing, this could be tax-deductible.

Are Loan Discount Fees Required?

Lenders do not require you to pay loan discount fees. If you are unable to come up with the extra funds upfront, you can opt out. They are designed merely to help lenders get more money in advance towards the loan and help home buyers save money over time.

Is Paying a Loan Discount Fee Is Worth It?

Paying a loan discount fee is only worth it for buyers in certain situations. To decide if it is right for you, you’ll first need to find the break-even point. This is the point at which you’ll start seeing the benefits of the extra savings eclipse your original upfront investment.

Discount fees become more beneficial the longer that you stay in the house. If you are only planning to live in your new home for a few short years, then it might not be worth it.

You also want to avoid letting your discount fees cut into the amount you put towards your down payment since this also affects how much interest you pay over time.

Are you curious about when you’ll hit the break-even point if you purchase discount points? Working with one of our home loan specialists can help you decide if this opportunity will benefit you during the home purchasing process.