What Is a Discount Fee on a Mortgage Loan?

What Is a Discount Fee on a Mortgage Loan?
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Discount fees on mortgages may or may not be beneficial to the borrower. Sometimes discount fees mean more income for the lender, but they can also mean a lower interest rate for the borrower.

Discount Fees and Mortgage Interest Rates

Interest rates
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Discount fees are a function of mortgage interest rates. Since most mortgages are sold in what is known as the secondary market, there is a market interest rate for mortgages that is determined at least once daily. So all mortgage interest rates are the same at any given time. That rate is called the "par" rate.

Why Discount Fees?

Discount fees are a means to adjust interest rates. If the current interest rate for a 30-year mortgage is 6 percent, then that is the par rate. Any adjustment to that rate will mean a change in the discount fee. For example, with a 30-year mortgage, each adjustment of one-eighth percent in interest rate means a discount fee of 0.5 percent will be paid or received.

Discount Fee as an Interest Rate Premium

Since the discount fee is a function of the interest rate, the interest rate that a borrower will pay on a mortgage can be adjusted by manipulating the discount fee. If a mortgage broker wants to make an extra 0.5 percent on a loan closing, the broker can quote a rate that is higher than the 6 percent par rate by one-eighth percent. When a higher than par interest rate is paid, the broker receives an interest rate premium, which is also known as a discount fee.

Discount Fee as a Buy Down.

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The reverse of the interest rate premium is the "buy down." This is when the borrower pays a discount fee to "buy down" the interest rate to a lower rate. For example, a borrower could pay a 0.5 percent discount fee and lower the interest rate from 6 percent to 5 7/8 percent. If the borrower paid 1 percent, the rate would then be 5 3/4 percent.

Understanding Mortgage Discount Fees

Knowing how mortgage discount fees work can make you a more savvy borrower and can save you a considerable amount of money in up-front fees or in long-term mortgage payments. Borrowers who understand mortgage discount fees (sometimes called points) will be able to negotiate more favorable loan terms. Generally it will take four to five years to recoup the cost of a buy down.