Lenders charge origination fees to cover the costs of making loans. These fees can increase your borrowing costs, whether you’re taking out a mortgage, a personal loan or an auto loan.
Before you borrow, it pays to know what an origination fee is, how it can influence loan costs and when to pay one.
What Is a Loan Origination Fee?
Typically, origination fees compensate lenders for processing loans, including handling applications, preparing documents and underwriting, says Ashley Luethje, loan officer with Paramount Residential Mortgage Group’s York, Nebraska, branch.
“An origination fee is a common fee that’s added to consumer, commercial and mortgage loans,” Luethje says. “These fees are typically a percentage of the loan amount that a consumer borrows and should be a realistic representation of the hard costs associated for the lender to produce the loan.”
A mortgage origination fee, she says, is usually about 1% of the total loan amount, but it can be more at the lender’s discretion.
How Much Should Origination Fees Be?
Origination fees depend on the type of loan and the amount you are borrowing.
Following a 1% guideline for mortgages, a $300,000 loan would have a $3,000 origination fee. But origination fees can vary widely for personal loans, and you could pay between 0% and 6%, depending on the lender.
The type of loan also determines how you pay an origination fee. With a home loan, the origination fee is usually paid as part of your closing costs, which can include fees for insurance premiums, taxes, discount points and more. You can either pay closing costs out of pocket or fold them into your loan, but then you will pay interest on them.
With a personal loan, lenders may deduct the origination fee from the loan proceeds or allow borrowers to pay the fee upfront. If you borrowed $30,000 and paid a 2% origination fee, the lender would collect $600 and you would keep $29,400.
Do All Lenders Charge an Origination Fee?
The short answer is no. Although mortgage origination fees were once customary because they were moneymakers, some lenders do not charge them because they now make money in other ways. Mortgages without origination fees, for example, could have higher interest rates.
Likewise, origination fees for personal loans, auto loans and private student loans are at the discretion of the lender, and some lenders may waive them.
The one time you’re guaranteed to pay a loan origination fee is when you take out a federal student loan. The fee hinges on the type of loan and when the loan is disbursed to you.
For example, a fee of 1.057% applies to Direct subsidized and unsubsidized loans disbursed from Oct. 1, 2020, to Sept. 30, 2021. The fee for Direct PLUS loans disbursed in the same time frame climbs to 4.228%.
The origination fee for a federal student loan is deducted from the loan proceeds, and you or your school receives the remainder to cover education costs.
Can You Negotiate the Origination Fee?
Borrowers can often negotiate origination fees for mortgages, auto loans, personal loans and private student loans, says Katie Bossler, quality assurance specialist with GreenPath Financial Wellness, a nonprofit credit counseling agency.
You could ask for a fee reduction, but the lender might be more willing if it is competing for your business.
Gather quotes from a few lenders and look through all of the loan details, Bossler says. “You may come out ahead to pay a higher origination fee if you are in turn being offered a lower interest rate on the loan,” she says.
Send the best quote to your preferred lender and ask if it can match or beat the offer. The lender might waive a fee or offer some other benefit, such as a lower annual percentage rate.
Why Do Lenders Charge Origination Fees?
Origination fees are just one way lenders make money on loans. When a loan doesn’t have an origination fee, the lender may try to compensate for that by charging other fees.
With mortgages, origination fees may be replaced with operational fees, such as:
- Rate-lock fees, which lenders charge to guarantee interest rates for a period of time.
- Commitment fees, which compensate lenders to set aside funds before loan approval.
- Underwriting and processing fees to evaluate and prepare the application and fund the loan.
“Loan fees by any other name are still loan fees,” says Dan Green, founder and CEO of the mortgage lender Homebuyer.
Instead of focusing solely on origination fees, he says, look at the loan in its entirety. For example, lenders might nix a mortgage origination fee but then hike up the APR.
Adds Luethje: “Lenders have the option not to charge an origination fee, which we sometimes see as a tactic used to generate additional business.”
Consumers might perceive a loan without an origination fee as less expensive, even if the overall cost is greater, and borrow more money.
“That being said, the lender still has costs associated with originating a loan, and if the upfront fee is not charged, it’s likely to be financed into the rate,” Luethje says.
Should You Choose a Loan With an Origination Fee?
If you’re unsure about whether to pay an origination fee, consider whether doing so could help you achieve your primary goal for the loan. “Origination fees are a trade-off,” Green says.
Homebuyers may choose to pay the origination fee to get a lower interest rate and lower monthly payment. A lower payment could also lead to a lower debt-to-income ratio.
As you weigh your decision, think about your time frame. How long do you need to recoup the origination fee, and how much will you save monthly if you pay it? If you plan to keep your loan long enough to recoup the cost, then paying the fee could make sense.
Loan size also matters. Paying the origination fee on a large loan could add up to thousands in savings.
Say that you need to borrow $250,000 to purchase new equipment for your construction business. You have two loan options to choose from:
- Loan A charges a 2% origination fee and has a 9.99% APR.
- Loan B has no origination fee but comes with an APR of 11.99%.
Both loans have five-year repayment terms. Loan A has a $5,000 origination fee and $68,632 in total interest charges, and Loan B has no fee but costs $15,000 more in interest.
Compare Loan Origination Fees and Rates Carefully
Obtain rate and fee quotes from several lenders, and calculate your bottom-line costs before you commit to a loan. That way, you can determine whether you could save with a loan that doesn’t have an origination fee.
“Take time to read the fine print and completely understand the terms of the loan,” Luethje says. “Having a basic understanding of why the fees are charged gives you the knowledge and ability to ask the right questions.”
However, don’t look at only the origination fees, she cautions. “Be sure to identify all the fees associated with a loan, as well as the interest rate, in order to truly get the best picture of the loan as a whole,” Luethje says.