Discount Point

A fee paid by the borrower at closing to reduce the interest rate. A point equals 1 percent of the loan amount.

Normally paid at closing and generally calculated to be equivalent to 1% of the total loan amount, discount points are paid to reduce the interest rate on a loan. In an ARM with an initial rate discount, the lender gives up a number of percentage points in interest to give you a lower rate and lower payments for part of the mortgage term (usually for one year or less). After the discount period, the ARM rate will probably go up depending on the index rate.

Some lenders require you to prepay a portion of the interest due on your mortgage as a condition of approving the loan. They set the amount due at one or more discount points, with each discount point equal to 1% of the mortgage loan principal.

For instance, if you must pay one point on a $100,000 mortgage, you owe $1,000.

From your perspective, the advantages of paying discount points are that your long-term interest rate is lowered slightly for each point you pay, and prepaid interest is tax deductible. The advantage, from the lenders' point of view, is that they collect some of their interest earnings up front.