What is an Origination Fee?

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Definition:

An origination fee is a fee that lenders charge for processing loans, often added to the initial balance of a loan.

🤔 Understanding origination fees

An origination fee is an additional cost that lenders sometimes add to loans to cover the expense of setting up the loan. Lenders typically add the fee to the initial balance of the loan. For example, if you borrow $100,000 and the lender charges a $1,000 origination fee, the first bill you get will show the loan’s starting balance as $101,000. Often, origination fees are charged as a percentage of the money that you borrow. Not every loan has an origination fee, so you may be able to save money by comparison shopping and choosing a lender that doesn’t charge origination fees.

Example

Imagine you decide to apply for a $10,000 personal loan. You compare multiple lenders and find that one charges a 2% origination fee, one charges a 5% origination fee, and one charges a $100 flat fee for originating loans.

With the first lender, your initial loan balance will be $10,200. With the second lender it will be $10,500. With the third lender, it will be $10,100. Assuming other aspects of the loans such as term and interest rate are equal, the third loan will be the cheapest.

Takeaway

An origination fee is like a cover charge at a club…

If you want to get into a club, sometimes you have to pay a cover charge. An origination fee is like a cover charge for a loan. If you want to borrow money from a lender, you have to pay the fee to do so, though most lenders will simply add the fee to your balance rather than make you pay it upfront.

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What is an origination fee?

An origination fee is a type of fee that lenders may add to loans. Many different kinds of loans, including mortgages, auto loans, and personal loans, may have origination fees, though not all lenders charge them.

Typically, lenders charge these fees to pay for some of the administrative costs related to setting up the loan. Unlike application fees, which you must pay when applying for a loan, you only pay an origination fee when you get approved and accept a loan.

Depending on the lender and the type of loan, you may pay a flat fee or a fee based on a percentage of the loan amount. For example, personal loans frequently charge fees between 1–8% of the amount borrowed.

Typically, you don’t pay the fee out of pocket when you receive the loan. Depending on the lender, there are two ways that you pay the charge.

One way is to deduct the cost from the amount that you borrow. For example, if you get a loan for $20,000 and pay a $500 origination fee, the lender will only deposit $19,500 to your account.

Another method is to add the cost to the initial balance of the loan. If you receive a $20,000 loan, the lender will deposit the full $20,000 to your bank account, but your first bill will show your balance as $20,500 ($20,000, plus the $500 fee).

Knowing about origination fees, and whether the lenders you want to work with charge them, is an important part of understanding the total cost of any loan for which you apply.

What is the purpose of origination fees?

One purpose of origination fees is to cover the cost of originating a loan. Processing an application, doing due diligence on potential borrowers, and disbursing funds can take time and cost the lender money. An origination fee can help the lender pay for the costs of setting up a loan.

The fees can also reduce the lender’s potential risk. If a lender doesn’t charge an origination fee, the only source of profit from the loan will be the interest the borrower pays.

If the borrower pays the loan off ahead of schedule, they’ll typically pay less interest than the lender anticipated, which could even result in a loss for the lender if the interest they do pay doesn’t cover the cost of originating the loan.

Origination fees are also a way to increase a lender’s revenue. Any chance to receive more money from borrowers is a chance for the lender to increase its revenues and profits, so some lenders use them simply as a way to make money.

What are examples of origination fees?

There are two main types of origination fees: flat fees and percentage-based fees.

A flat origination fee does not change based on the amount that you borrow. For example, a lender may charge a $500 fee for every loan that it disburses. If you borrow $10,000, you’ll pay a $500 fee for the loan. If you borrow $25,000, you’ll still pay a $500 fee.

Some lenders charge percentage-based origination fees, which vary with the amount that you borrow. These are common for loans such as personal loans. Typically, these fees range from 1–8%.

For example, imagine you apply for a $10,000 loan from a lender that charges a 3% origination fee. If you receive the loan, the fee will total $300. If you instead applied for a $20,000 loan, the lender would charge a $600 fee. With percentage-based fees, the more you borrow, the higher the fee.

When should you pay origination fees?

Any time you pay a fee, you’re adding a cost to your loan. However, that doesn’t mean that paying origination fees is always a bad thing.

When you apply for a loan, it’s generally a good idea to check out multiple lenders and get competing offers so you can find the best deal. Sometimes, you can find a loan that charges an origination fee, but has a lower total cost because of other factors, such as a lower interest rate.

Always look at the total cost of a loan when making your decision. If a lender charging an origination fee is offering the loan with the lowest total cost, paying the origination fee likely makes sense. A good way to do this is to look at the APR, rather than the interest rate, which accounts for all costs of the loan.

How do you minimize origination fees?

There are a few ways to minimize your origination fees.

One is to negotiate. With many lenders, you can often work to make a deal, reducing your interest rate, or cutting origination fees. It’s easier to do this if you have some sort of leverage, so getting offers from multiple lenders and making them compete for your business can make this easier.

Some lenders are willing to reduce or eliminate origination fees for people with strong credit, so make sure you take steps to improve your credit score before applying for a loan that may include a charge.

If you’re applying for a home loan, you can also negotiate with the seller to see if they’ll cover the origination fee for you. Again, this works better if you have leverage.

Can you negotiate the origination fee?

You can often negotiate origination fees, though not all lenders will be willing to work with you. Still, the worst that can happen is that your lender says they won’t reduce the fee, so you generally have nothing to lose by trying.

To negotiate effectively, you usually need to have leverage or offer some kind of give and take. One good strategy is to get offers from different lenders. You can then use competing offers to try and convince your preferred lender to give you a better deal.

Another option, especially with mortgage lenders, is to offer a quid pro quo of sorts, accepting a higher interest rate, providing collateral, or making a larger down payment for a reduced origination fee.

Just make sure you’re not increasing the total cost of your loan by bumping up the interest rate. You don’t want to spend thousands of dollars to save hundreds. APR is a good way to compare loans because it accounts for all costs, including fees and interest.

How much should you pay in origination fees?

Origination fees typically vary from loan to loan but they average between 1–8% of the amount that you borrow.

Mortgage lenders tend to charge flat amounts or low percentages of the amount that you borrow.

Generally, you should aim to pay the lowest fee possible, though paying a higher fee often makes sense if it reduces the total cost of the loan due to other factors, such as a lower interest rate.

What is the average loan origination fee?

The average origination fee will vary based on the type of loan you’re applying for, the lender, and the amount of the loan. Overall, origination fees average between 1–8% of the amount that you borrow. The typical mortgage origination fee is about 1% of the amount that you borrow.

How do you calculate origination fees?

There are two types of origination fees: flat fees and percentage-based fees.

With a flat fee, you don’t need to calculate the charge. The lender will tell you how much the charge is.

With a percentage-based fee, you need to multiply the percentage by the loan amount to find the total charge. For example, a 2% origination fee on a $100,000 loan can be calculated like this:

$100,000 .02 = $2,000*

What is the difference between an origination fee and discount points?

An origination fee is a charge you typically pay to compensate the lender for the cost of setting up a loan.

Discount points are a type of optional charge that borrowers can pay when they receive a loan, typically a mortgage. Often, in exchange for the borrower paying for points, the lender reduces the interest rate of the loan.

Can I deduct loan origination fees on my tax return?

The IRS lets borrowers deduct some housing costs, such as mortgage interest, from their income when they file their tax return.

You may be able to deduct some of the closing costs and origination fees, though you should ask your lender for a breakdown of the costs included in the fee to know what you can deduct.

You may deduct things like mortgage points and mortgage insurance, but cannot deduct things like the appraisal, notary, and document preparation fees.

Keep in mind, if you pay the fees out of pocket, you get a one-time, larger tax deduction. If you pay them as part of your monthly payment, you can get deductions over the life of the loan. If you’re uncertain which option is best for you, you may wish to consult a tax professional.

What are some other closing costs?

Many loans, especially mortgage loans, charge other closing costs in addition to origination fees.

Some examples of closing costs you may have to pay include:

  • Points
  • Appraisal fee
  • Credit report fee
  • Tax service fee
  • Flood certificate fee
  • Life of loan flood monitoring fee
  • Title fees
  • Recording fees
  • Surveyal fees
  • Prepaid interest
  • Homeowner’s insurance
  • Property taxes
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