Whenever you’re applying for a new loan, understand how a loan origination fee impacts the total cost of the loan so you can accurately compare loan offers.
Many lenders charge a loan origination fee to cover the costs of evaluating borrowers and creating loans. The loan origination fee amount varies by lender. In some cases, lenders may not charge a loan origination fee at all, instead rolling their costs into other parts of the loan.
A Deeper Look at Loan Origination Fees
Loan origination fees, also referred to as administrative fees, service fees or processing fees, cover the costs of underwriting and borrower verification, as well as the process of creating, documenting and administering new loans. Loan origination fees are a way for the lending institution to make money.
A loan origination fee is a one-time, upfront charge that is usually calculated as a percentage of the loan balance.
The typical amount of a loan origination fee depends on the type of loan. For example, mortgage loan origination fees average between 0.5% to 1.0% of the total loan amount. Personal loan origination fees may be much higher — as high as 8% to 10% of the loan amount.
How Loan Origination Fees Work
As stated above, a loan origination fee is a one-time charge that lenders typically calculate as a percentage of the total loan amount. Lenders may ask that you pay the origination fee up front, agree to take it out of the funds you receive or add it to the loan principal. For personal loans, lenders commonly subtract the origination fee from the loan amount.
To see how loan origination fees impact a loan’s total cost, imagine taking out a personal loan for $10,000. A loan origination fee of 5% would result in a $500 charge. If the lender subtracts your loan origination fee from the loan balance, you would receive a $9,500 deposit or check instead of the full $10,000.
Alternatively, if the lender added the origination fee to the loan principal, you would pay interest on the fee in addition to the funds you borrowed. In this case, your loan amount would equal $10,500, and your monthly principal and interest payments would cover the loan origination fee over the entire life of the loan.
Choosing a repayment option is an important consideration, as different options may be more or less expensive. In general, subtracting the origination fee from the total loan amount will likely be a less expensive option. However, it will lower the funds you have available. Be sure to ask your lender which payment methods are available to you and understand the true cost of each option.
How Loan Origination Fees Are Determined
Multiple factors influence the amount of the loan origination fee charged to individual borrowers. First and foremost, different lenders may operate according to internal policies and practices that dictate the fees they charge. Researching different lenders will give you an idea of which lenders charge higher fees than others — although it’s important to realize that lenders who charge lower fees or no fees are likely incorporating their costs into other parts of the loan.
The loan type and amount also determine the amount of the loan origination charges. For example, the loan origination fee for a mortgage loan with a high balance may be a lower percentage compared to a personal loan with a smaller loan balance. This is because the cost of processing loans is generally the same: Lenders need to charge a higher percentage of smaller loan balances to cover their costs.
Additionally, the borrower’s credit history may impact the loan origination fee. A higher credit score may afford you a lower loan origination fee, while a high debt-to-income (DTI) ratio might result in a higher loan origination fee. Ultimately, actual loan origination fees are highly customized to individual borrowing situations.
Should You Consider Loans That Charge an Origination Fee?
When comparing loans, it may be tempting to consider only loans that do not charge an origination fee. But remember that in the absence of an origination fee, those costs may be rolled into another cost of the loan, like the interest rate. For this reason, be sure to compare both loans with origination fees and loans without origination fees.
For example, let’s say you’re comparing two personal loans from different lenders with a loan amount of $50,000 and a repayment term of 10 years. Loan A has a 5% origination fee and an 8% interest rate. The origination fee for Loan A amounts to $2,500 ($50,000 x .05 = $2,500). The monthly payment equals $607, with a total of $22,796.56 paid in interest over the life of the loan.
Loan B has no origination fee and a 10% interest rate. The monthly payment equals $661, with a total of $29,290.44 paid in total interest over the 10-year repayment term. Loan B requires the borrower to pay an extra $6,493.88 in interest over the loan term ($29,290.44 – $22,796.56 = $6,493.88). In this case, the $2,500 origination fee on Loan A is a cheaper option than Loan B because Loan A has a lower interest rate.
>> Related:Learn more about the best personal loans with no origination fees
How To Save on Loan Origination Fees
To find the lowest-cost loan with the best terms for your situation, it’s important to compare offers from multiple lenders. Different lenders may have different policies regarding loan origination fees or may be more willing to negotiate fees.
As you’re comparing lenders, you may find that some lenders charge origination fees while others don’t. This can make it difficult to compare loan offers apples-to-apples. Lenders have to make money somehow, so loans with no origination fees often come with higher interest rates to cover the lender’s costs.
Additionally, ask each lender you’re considering about the possibility of negotiating fees. Some lenders may be more or less willing to negotiate, although you should be aware of how negotiations may change other terms of the loan. For example, if you negotiate to remove a loan origination fee but that results in a higher interest rate, calculate the cost of the higher interest rate over the life of the loan to determine whether it’s worth it to have the fee waived.
To effectively negotiate, gather loan estimates from all the lenders you’re considering. Once you have the offers in hand, approach your preferred lenders with the best offers and ask if they’d be willing to match or beat their competitors. If a lender realizes you may go with someone else, they may be more likely to waive or reduce a fee.
No-origination-fee loans may be preferable in some cases. Institutions like credit unions may be able to offer loans with no origination fee and a low interest rate. Keep in mind that most credit unions require you to be a member to be eligible for their loan products. Membership requirements vary by credit union and commonly include geographical considerations, occupation type or military status.
Consider no-origination-fee loan options, but take into account the lender and the entire cost of the loan before making a decision.
When comparing loans — especially loans with origination fees vs. no origination fees — it’s important to compare the overall cost of each option. The annual percentage rate (APR) of any loan includes the interest rate on the loan as well as other fees, including loan origination fees. Therefore, comparing APRs across different loans can be a simple way to compare total loan costs.
The Bottom Line
When comparing loan offers, understanding loan origination fees is key to making an informed decision. Not all lenders charge loan origination fees, but all lenders have to make money somehow. If you’re considering a loan without an origination fee, be sure to assess how the interest rate or other loan costs may be different from loans with an origination fee.
Conducting thorough research and taking the time to understand the total costs of any given loan is the best way to accurately compare loan offers. Before you commit to a loan, compare the total costs of each to ensure you’re getting the best deal.
Frequently Asked Questions About Loan Origination Fees
There are a few options to avoid loan origination fees. You can try negotiating with the lender to waive or reduce the loan origination fee, or you can seek out loan offers with no origination fee. If you take this route, be sure to consider whether or not there is a higher interest rate or other fee assessed in place of the loan origination fee.
An origination fee is a one-time payment made to the lender upon processing your loan. The origination fee is not a deposit, so you don’t get it back after you make your final payment.
The origination fee includes administrative services required to process a loan, like underwriting, borrower verification and application reviews. Origination fees are one of the primary ways lenders make money.
The processing fee for a loan is the same as a loan origination fee. Lenders may include the processing costs in the interest rate on loans that do not have a processing fee.
Editor’s Note: Before making significant financial decisions, consider reviewing your options with someone you trust, such as a financial adviser, credit counselor or financial professional, since every person’s situation and needs are different.
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