'Discount Fee' is explained in detail and with examples in the Real Estate edition of the Herold Financial Dictionary, which you can get from Amazon in Ebook or Paperback edition.
Discount fee refers to an upfront closing cost on a mortgage. This one time arrangement provides a mortgage borrower with the ability to enjoy lower mortgage rates than the general market offers. These discount points are often tax deductible. This is because the IRS counts these points as mortgage interest that is prepaid. The discount fee varies from one bank to another in how much it lowers the interest rate on the mortgage. Typically, a single discount point that a buyer pays in the closing will reduce the interest rate on the mortgage by 25 basis points, or .25%.
Mortgage lenders commonly quote their own current mortgage rates as two parts. In the first part, they provide the official mortgage rate which they are offering. In the second part they reveal the amount of discount fee that the borrower will need to pay to reach that rate. Generally speaking, the more points the home buyer pays, the lower the quote on the mortgage rate will become.
Ultimately the discount fee is a means of buying down the interest rate. This lowers the monthly payments. It is separate from origination points. These are costs that banks levy in order to prepare the mortgage loan.
Settlement statements may label this discount fee under another name. They can be termed mortgage rate buy down or discount points. These points carry a cost of 1% of the total size of the loan. With a $300,000 loan, a single point would cost $3,000. Half a point would amount to $1,500. A quarter point would equal $750.
The tax advantage of these discount points pertains to taxes a home buyer pays now. They are completely deductible in the year the borrower buys them. Individuals are not allowed to claim the full deduction on loans for home refinance. These must be spread out for the entire life of the refinance loan. This means that for a home owner who buys points for a 30 year refinance mortgage, he or she is able to claim 1/30 of the fees every year in tax deduction. For any borrower who decides to buy these points on a mortgage, it makes sense to discuss it with the tax advisor so that the deductions on federal income tax can be maximized.
The other reason that a home buyer would be interested in buying points is because it can lower the monthly payments and the total amount of money paid during the life of the mortgage loan. On a $100,000 loan a standard discount point would reduce payments by $14 each month for every $1,000 spent. This leads to a breakeven time frame of 71 months.
In order for buying points to make sense, the mortgage borrower has to decide how long he or she will likely hold the house or the mortgage. If the owner plans to sell the house in less than this amount of time, or he or she will refinance the loan sooner, then paying for points becomes a waste of money. If an owner will hold a mortgage for more than the six years in this example, then the savings over the remaining 24 years of the mortgage can be substantial.
Freddie Mac keeps statistics on average mortgage loans and points. In the year 2015, the average fixed rate loan came with .6 discount points. With the average ARM adjustable rate mortgage, .5 discount points came in the contract. The exact amount of an interest rate break that a point carries depends on the bank in question. Some banks also do not give multiples of .25% interest rate breaks on each point the borrower purchases.