Discount is used in banking referring to an adjustment made to reach a desired interest rate stated on a mortgage. The Discount is essentially the difference between the price that an investor pays for a security and its face value, taking into account interest, insurance, and principal payment amounts. If a mortgage does not qualify for the desired rate, the principal balance of the loan can be effectively reduced with the prepayment of Discount points. The amount of prepayment is calculated as a percentage of the total stated mortgage. Each Discount point is equal to one percent of the original mortgage. The prepayment is described as a number of Discount points. For example, if a $100,000 mortgage qualifies for a 4% mortgage and the investor wants to establish the mortgage at 3.75%, the mortgage company may require the investor to pay 6.25 points. This calculation is based on simple interest. In this example, paying $6,250 in advance would reduce the effective principal balance to $93,750. $93,750 times 4% equals $3,750 which is the anticipated interest at 3.75% on a $100,000 mortgage. In fact $3,750 is 4% of the effective mortgage principal balance of $93,750 after the prepayment of 6.25 points. Although this example is representative of the process, variations in the actual method of calculation and negotiations between the investor and mortgage broker may influence the number of points a mortgage company or other banking institution requests to achieve a stated interest rate.

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