The medial habenula-interpeduncular nucleus (MHb-IPN) pathway has recently been implicated in the suppression of fear memory. A notable feature of this pathway is the corelease of neurotransmitters and neuropeptides from MHb neurons. Our studies in mice reveal that an activation of substance P-positive dorsomedial habenula (dMHb) neurons results in simultaneous release of glutamate and glycine in the lateral interpeduncular nucleus (LIPN). This glycine receptor activity inhibits an activity-dependent long-lasting potentiation of glutamatergic synapses in LIPN neurons, while substance P enhances this plasticity. An endocannabinoid CB1 receptor-mediated suppression of GABAB receptor activity allows substance P to induce a long-lasting increase in glutamate release in LIPN neurons. Consistent with the substance P-dependent synaptic potentiation in the LIPN, the NK1R in the IPN is involved in fear extinction but not fear conditioning. Thus, our study describes a novel plasticity mechanism in the LIPN and a region-specific role of substance P in fear extinction.