Discount Points

Discount Points, also known as a discount or a damnum, is an important term in finance that plays a role particularly in lending transactions and bonds. This article explains what a Discount Points is, how it is calculated, what reasons there are for a Discount Points to occur and what advantages and disadvantages it entails for the parties involved.

Discount Points Definition: What is Discount Points?

A Discount Points, also known as mortgage points or simply points, is a discount that arises when taking out a loan or issuing a bond. It refers to the difference between the nominal value (the amount on the paper) and the amount actually paid out. For example, if a loan of EUR 100,000 is taken out but only EUR 95,000 is paid out, the Discount Points are EUR 5,000 or 5 percent of the nominal value.

The Discount Points is often used to increase the effective interest rate of a loan without changing the nominal interest rate. It represents an anticipated interest payment that immediately gives the lender or investor an advantage. This is taken into account when calculating the effective cost of a loan and can have tax implications. In practice, this means that the borrower receives less money than they actually owe, resulting in higher effective financing costs.

Overall, Discount Points are an important aspect of loan and bond pricing that has various financial implications for both borrowers and lenders.

What are Discount Points used for?

To increase the effective interest rate: Discount Points can be used to increase the actual interest rate on a loan without increasing the nominal interest rate. This can be attractive for lenders as it allows them to achieve higher returns.
Financial flexibility: Companies and public institutions use Discount Points to obtain immediate cash while deferring repayment to a later date. This can be helpful to cover short-term financing needs.
Tax advantages: In some countries, the Discount Points may be tax-deductible, which can reduce the tax burden for the borrower.
Risk compensation: For the lender, the Discount Points represent a kind of risk compensation, as they receive part of the repayment in advance.

When are Discount Points applied?

When taking out a loan: When a company or private individual takes out a loan, a Discount Points can be agreed. The borrower then receives a lower payout amount than the nominal amount of the loan.
When issuing bonds: Issuers of bonds, such as companies or governments, can use a Discount Points to make bonds more attractive. The bond is sold for less than the face value and the investor receives the full face value back at maturity.
In times of high interest rates: When market interest rates are high, borrowers can accept a Discount Points to lower the nominal interest rate of the loan and make monthly interest payments more affordable.
For refinancing: When refinancing existing debt, a Discount Points can be used to optimize the terms of the new financing.

By applying a Discount Points, both lenders and borrowers can produce certain financial benefits, although it results in higher effective financing costs for the borrower.

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Advantages & Disadvantages of Discount Points

This table provides a clear overview of the advantages and disadvantages of Discount Points for both sides, making it easier to weigh up the decision to apply a Discount Points.

For whom?	Advantages	Disadvantages
For the borrower / issuer	Increase in liquidity	Provides more funds available in the short term, as less than the nominal value is paid out.	Less funds than the full loan or bond amount are immediately available.
	Tax advantages	In some cases, the Discount Points may be tax deductible, which can reduce the tax burden.	Not always tax deductible, depending on tax laws and regulations.
	Attractiveness of financing	Allows the borrower to present seemingly lower interest rates, which can make financing more attractive.	Higher effective costs and possibly more complicated calculation of actual costs.
	Flexibility in financing	Can be used to optimize different financing strategies, especially for long-term projects or investments.	Increases the complexity of financing and requires careful planning and calculation.
For the lender / investor	Immediate capital inflow	The lender or issuer immediately receives a portion of the amount owed, which increases liquidity.	The borrower receives fewer funds, which can reduce the attractiveness of the loan or bond.
	Risk reduction	The Discount Points serves as a risk buffer and reduces the default risk for the lender.	Cannot completely eliminate risk and may lead to higher effective financing costs for the borrower.
	Attractiveness to investors	Increases the attractiveness of bonds as the effective yield is higher when issued below par.	Potentially higher risk for investors, as the actual costs and risks are higher than initially expected.
	Competitiveness	Provides the lender or issuer with the opportunity to bid competitively by offering seemingly lower interest rates.	Increases the effective cost and may increase the long-term financial burden on the borrower.
General	Market attractiveness	Can increase demand for certain forms of financing by offering higher effective yields.	Can negatively affect the borrower's credit rating and limit future financing options.
	Flexibility in interest rate structure	Allows financing to be adjusted to current market conditions without changing the nominal interest rate.	Increases the complexity of financing and requires precise calculations and transparency to avoid misunderstandings.

Discount Points Tax Law

Discount Points have various effects in tax law that are relevant for both borrowers and lenders. Here is an overview of the most important points.

Overview: Discount Points Tax Law Actors

The following diagram shows the two actors to whom the tax effects of Discount Points apply.

Explanation: Discount Points Tax Law for the 2 Actors

Discount Points offer tax advantages by reducing the borrower's tax burden through deductibility as a business expense or income-related expense. However, it also increases the complexity of bookkeeping and accounting. Both borrowers and lenders must carefully examine the tax implications and prepare their accounts accordingly in order to make the most of the benefits and comply with legal requirements.

For the Lender

Income from Discount Points
- The lender must pay tax on the Discount Points received as interest income. This income is included in the income statement and is subject to corporation tax.
Accounting
- In the lender's balance sheet, the Discount Points are recognized as deferred income, which is reversed over the term of the loan.

For the Borrower

Deductibility as a business expense
- The Discount Points can be deducted as a business expense for tax purposes in the year the loan is taken out or over the term of the loan. This reduces the borrower's tax burden.
- Discount Points are often amortized over the term of the loan in accordance with tax regulations.
Accounting
- Discount Points are shown as prepaid expenses in the borrower's balance sheet. This item is amortized over the term of the loan.
Income tax treatment
- For private individuals who use the Discount Points in connection with income from letting and leasing, the Discount Points can be deducted as income-related expenses.

Important terms relating to
Discount Points

Terms relating to Discount Points

Term	Meaning
Discount Points (Abgeld)	Discount that arises when taking out a loan or issuing a bond if the amount paid out is less than the nominal value.
Premium	Premium that arises when bonds or shares are issued if the issue price is higher than the nominal value.
Nominal value	The value on paper of a financial instrument such as a loan or bond.
Payout amount	The actual amount paid out on a loan or bond issue, less the Discount Points.
Effective interest rate	The actual interest rate of a loan or bond that takes into account all costs, including Discount Points.
Nominal interest rate	The interest rate stated in the loan agreement or on the bond, excluding Discount Points or other costs.
Issue	The issuance of bonds or shares by a company or government to raise capital.
Borrower	The person or company that takes out a loan and owes repayment, including interest and fees.
Lender	The bank or financial institution that grants the loan and receives interest and repayment of the principal amount.
Bond	A debt instrument issued by companies or governments to raise capital.
Loan	A long-term loan, usually used for specific purposes such as buying a house or property.
Loan	A borrowed capital that must be repaid, often with interest, within a specified period of time.
Credit card	A means of payment that allows the holder to purchase goods and services on credit, where interest may accrue on the outstanding balance.
Payment providers	Companies that provide payment services and process transactions between buyers and sellers, often for a fee.
Transaction fee	A fee charged when using financial services such as credit cards or payment providers.
Refinancing	The replacement of an existing loan with a new loan, often to obtain better terms.

This table provides an overview of the most important terms related to Discount Points and their meanings.

Differences & Similarities of Discount Points in different areas:

Credits, Bonds, Loans, Credit Cards and Payment Providers

This table shows the differences and similarities of Discount Points and similar financial discounts in different areas.

Feature	Credits	Bonds	Loans	Credit Cards	Payment Providers
Definition	Discount when borrowing	Discount when issuing bonds	Discount when taking out a loan	No typical Discount Points, but high fees possible	No typical Discount Points, but fees and deductions possible
Application	When borrowing	When issuing bonds	When taking out long-term loans	In the form of high interest rates and fees	In the form of transaction fees or currency conversions
Calculation	Discount Points = nominal value - payout amount	Discount Points = nominal value - issue proceeds	Discount Points = nominal value - payout amount	Usually no direct calculation as Discount Points	Fees = amount 脳 percentage of transaction costs
Percentage calculation	(Discount Points / Par Value) 脳 100	(Discount Points / Par Value) 脳 100	(Discount Points / Par Value) 脳 100	Fees often as a percentage of the transaction	Fees often as a percentage of the transaction
Financial effect	Increases the effective cost of credit	Increases the effective cost of issuance	Increases the effective cost of the loan	Increases the effective cost of credit utilization	Increases the cost of the transaction
Purpose	To increase effective interest rates	To make bonds more attractive	To increase effective interest rates	To generate revenue for the provider	To generate revenue for the provider
Tax treatment	May be tax deductible	May be tax deductible	May be tax deductible	Fees may be deductible	Fees may be deductible
Risk for users	Higher effective cost of borrowing	Higher effective cost for investors	Higher effective cost of the loan	High interest and fees	High transaction costs
Impact on provider	Receives part of repayment upfront	Receives additional funds on issuance	Receives part of repayment upfront	Generates revenue through fees	Generates revenue through fees
Example	Loan of 鈧�100,000, payout of 鈧�98,000	Bond with a nominal value of 鈧�1,000, sale for 鈧�980	Loan of 鈧�50,000, payout of 鈧�49,000	Credit card with 3% transaction fee	Payment provider with 2.5% fee per transaction

Calculate Discount Points

Calculating a Discount Points is relatively simple and is usually done by determining the difference between the face value and the payout amount of a loan or bond. These calculations are useful for understanding the effective cost of a loan or bond and assessing the financial impact of a Discount Points.

Discount Points Formula

Here is the general formula for the Discount Points:

The following formula can be used to calculate the percentage of Discount Points:

The Discount Points percentage indicates what percentage of the nominal value is retained as a discount.

Discount Points Example

A Discount Points can occur in various financial contexts. Here is a concrete example that illustrates the calculation and effects of a Discount Points:

Example:

A company needs a loan of 100,000 euros. The bank offers a loan at a nominal interest rate of 5%, but with a Discount Points of 2%.

Step 1: Calculation of the Discount Points in Euro

The nominal value of the loan is 100,000 Euro and the disbursement amount is reduced by 2% due to the Discount Points.

Discount Points = 100,000 Euro 脳 0.02 = 2,000 Euro

Step 2: Calculation of the Payout Amount

The disbursement amount of the loan is therefore reduced by the Discount Points:

Payout Amount = 100,000 Euro - 2,000 Euro = 98,000 Euro

Step 3: Calculation of the Effective Costs

Although the company receives 98,000 Euro, it must repay the full nominal value of 100,000 Euro, in addition to the interest.

The annual interest is calculated on the nominal value:

Annual Interest = 100,000 Euro 脳 0.05 = 5,000 Euro

If the loan has a term of one year, the company pays at the end of the year:

Total Repayment = 100,000 Euro + 5,000 Euro = 105,000 Euro

Step 4: Calculate the Effective Interest Rate

To calculate the effective interest rate, we need to relate the total cost of the loan to the actual amount paid out:

Effective Interest Rate = (Total Repayment Payoff Amount / Payoff Amount) 脳 100

Let's insert the values:

Effective Interest Rate = (105,000 Euro - 98,000 Euro / 98,000 Euro) 脳 100 = 7.14

In this example, the company has taken out a loan of 100,000 euros with a Discount Points of 2%. The actual amount paid out is 98,000 euros, while the repayment including interest is 105,000 euros. This results in an effective interest rate of 7.14%, which is higher than the nominal interest rate of 5%, reflecting the additional costs due to the Discount Points.

Difference between Agio and Discount Points

This table provides a clear overview of the main differences between Agio and Discount Points, their calculation, application and impact on the parties involved.

Characteristic	Agio	Discount Points
Definition	Premium, the amount that exceeds the nominal value	Discount, the amount that is below the nominal value
Use	When issuing bonds or shares above par value	When borrowing or issuing bonds below par value
Financial effect	Increases the amount received by the issuer	Reduces the amount received by the borrower
Purpose	To raise additional funds	To increase the effective interest rate without changing the nominal interest rate
Example	A share with a nominal value of 100 euros is sold for 105 euros	A loan of 100,000 euros where only 98,000 euros are paid out
Calculation	Agio = selling price - nominal value	Discount Points = nominal value - amount paid out
Percentage calculation	Agio percentage = (Agio / Nominal value) 脳 100	Discount Points percentage = (Discount Points / Nominal value) 脳 100
Tax treatment	May be taxed as capital gains	May be treated as a deductible expense, depending on tax regulations
Risk for investors/borrowers	Higher risk as the purchase price is higher than the nominal value	Higher effective costs for the borrower
Impact on issuers/lenders	Additional funds when issuing bonds or shares	Receives part of the repayment upfront

FAQ

What is a Discount Points in accounting?

A Discount Points in accounting is the discount that arises when a loan or bond is disbursed at an amount lower than the nominal value. This amount is recognized as prepaid expenses and amortized over the term of the loan or bond.

How high can a Discount Points be?

The amount of the Discount Points is contractually agreed and can vary depending on the credit institution and market conditions. There is no legal upper limit, but the Discount Points should be within the bounds of economic reason and the usual market conditions.

When is a Discount Points worthwhile?

A Discount Points is worthwhile if you want a lower monthly interest charge in the short term and want to take advantage of tax benefits by being able to deduct the Discount Points as a business expense.