What Is a Loan Discount Fee and How Does It Work?

A loan discount fee is an upfront charge you pay your mortgage lender at closing to permanently lower the interest rate on your loan. It’s usually called “points” or “discount points,” and one point costs 1% of the amount you’re borrowing. Each point you buy generally shaves about 0.25% off your rate, though the exact reduction depends on the lender and current market conditions.¹ Because the IRS treats this money as prepaid interest rather than a service fee, you can often deduct it on your federal taxes.

What One Point Costs and What It Buys

The math is simple. One point equals 1% of the loan amount, not the home’s price. On a $300,000 mortgage, one point is $3,000. On a $500,000 mortgage, one point is $5,000. You can buy fractional points too, like half a point or a point and a half.

In exchange, your interest rate drops by roughly a quarter of a percentage point per point purchased. Paying two points on a $400,000 loan, for example, might take a 7.0% rate down to about 6.5%, which lowers your monthly payment and cuts the total interest you pay across the life of the loan. The reduced rate is locked in when you finalize the loan terms and stays with the mortgage for as long as you keep it.

When Paying Points Pays Off

Points are a bet on time. You pay more at closing to save money every month, so the trade only works if you keep the mortgage long enough for the monthly savings to add up to more than the upfront cost. That crossover point is called the break-even period, and the calculation is:

Cost of the points ÷ Monthly savings = Break-even period in months

Pay $4,000 in points to lower your monthly payment by $56, and you break even at about 71 months, or just under six years. Every payment after that is a net gain compared with taking the higher rate.

The median homeowner now stays in their home about 11 years before selling, comfortably past a typical break-even window of four to seven years.² So for a buyer planning to settle in, points often make sense. If you expect to sell, refinance, or pay off the loan within a few years, you may never reach break-even, and the upfront money is lost.

Lender Credits Run the Other Direction

Lender credits are the reverse trade. You accept a slightly higher rate, and the lender covers part of your closing costs. If holding onto cash at closing matters more than the long-term rate, or you don’t plan to keep the loan long, credits can come out ahead. If you’re staying put, points usually win.¹

Deducting Points on Your Taxes

Because the IRS treats discount points as prepaid interest, they can be deducted on your federal income tax return.³ When you use a loan to buy or build your main home, you can generally deduct the full cost of the points in the year you paid them, but only if you meet every one of the following conditions:

The loan is secured by the home you live in most of the time.
You used it to buy or build that main home.
Paying points is a customary business practice in your area, and the amount you paid is within the local norm.
You use the cash method of accounting, which most individuals do.
The points weren’t charged in place of fees normally itemized separately, like appraisal fees, title fees, or property taxes.
The cash you brought to closing (down payment, escrow, earnest money) was at least equal to the points, and none of it was borrowed from the lender.
The points are calculated as a percentage of the loan and clearly shown on your closing paperwork.

Miss any of those tests and you don’t lose the deduction. You just have to spread it evenly across the life of the loan instead of taking it all at once.

You Have To Itemize

Points are claimed on Schedule A as part of your itemized deductions, so they only help if your itemized total beats the standard deduction. For tax year 2026, the standard deduction is $16,100 for single filers, $32,200 for married couples filing jointly, and $24,150 for heads of household.⁴ If your combined mortgage interest, points, state and local taxes, and other deductions don’t clear that number, the points deduction doesn’t lower your tax bill.

The mortgage interest deduction, including points, also only applies up to a capped amount of mortgage debt. Under rules in effect through 2025, that cap was $750,000 in total mortgage debt, or $375,000 if married filing separately, with a legacy $1 million limit for loans taken out before December 16, 2017. Check current IRS guidance before you file, since the threshold can change.³

Refinances, Second Homes, and Improvement Loans

Refinances get treated differently. Points paid to refinance can’t be deducted all at once; they’re spread over the term of the new loan. If you had unamortized points left from the old loan, what happens next depends on the lender. Refinance with a different lender, and you can deduct the remaining balance of the old points in the year of the refinance. Refinance with the same lender, and you roll the old points into the new ones and amortize the whole amount over the new loan’s term.³

If you sell or pay off a mortgage early while you’re still amortizing points, you can deduct the entire remaining balance in the year the loan ends.³

Points on a loan secured by a second home are never fully deductible in the year paid. They must be spread over the life of the loan even if every other test is met.³

Points paid on a loan used to substantially improve your main home can be fully deducted in the year paid, as long as the loan is secured by that home and the standard tests are satisfied.³ Points on loans for rental or investment properties follow different rules and are generally amortized across the loan term.⁵

When the Seller Pays the Points

Sellers often agree to cover part of a buyer’s closing costs, and that can include discount points. Even when the seller writes the check, the buyer is the one who gets to claim the deduction, provided the same IRS tests for a full first-year deduction are met. The catch is that the buyer has to reduce the home’s cost basis by the amount of seller-paid points, which can raise the taxable gain when the home is eventually sold.³

How much a seller is allowed to contribute varies by loan program and down payment. For Fannie Mae conventional loans on a primary or second home, seller contributions are capped at 3% of the sale price or appraised value when the down payment is under 10%, 6% when it’s between 10% and 25%, and 9% when it’s 25% or more.⁶ FHA and VA loans set their own limits. Anything above the cap gets treated as a price reduction instead of a credit.

Where Points Show Up in Your Paperwork

You’ll see discount points quoted well before you sign anything. The Loan Estimate, which your lender must deliver within three business days of receiving your application, lists points in the Origination Charges section along with the percentage charged, the dollar amount, and the resulting rate.⁷ Comparing this form across lenders is the easiest way to see whether points are priced fairly and how much rate they actually buy.

At least three business days before closing, you receive a Closing Disclosure with the final terms.⁸ Points appear again in the Loan Costs section. Line them up against the Loan Estimate to catch any changes. At the settlement table, the cost of the points is folded into your total cash-to-close, paid by wire or cashier’s check to the settlement agent.

After year-end, your lender sends Form 1098 reporting the mortgage interest and points you paid. Lenders must issue it for any borrower who paid at least $600 in mortgage interest for the year.⁹ Those figures are what you use on Schedule A when you claim the deduction.

1
Consumer Financial Protection Bureau. How Should I Use Lender Credits and Points (Also Called Discount Points)?
2
National Association of Realtors. NAR 2025 Profile of Home Buyers, Sellers Reveals Market Extremes
3
Internal Revenue Service. Publication 936 (2025), Home Mortgage Interest Deduction
4
Internal Revenue Service. IRS Releases Tax Inflation Adjustments for Tax Year 2026
5
Internal Revenue Service. Topic No. 504, Home Mortgage Points
6
Fannie Mae. Interested Party Contributions (IPCs)
7
Consumer Financial Protection Bureau. What Is a Loan Estimate?
8
Consumer Financial Protection Bureau. What Is a Closing Disclosure?
9
Internal Revenue Service. About Form 1098, Mortgage Interest Statement