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Always compare origination fees as they can have a big impact on how much you pay overall.
There are different ways for a lender to make a profit on a loan. One of the ways that most of us are familiar with is by charging interest. But another way is by charging origination fees upfront.
When you're shopping for a loan, you'll want to be sure to compare origination fees (sometimes considered "hidden" fees) as they can have a big impact on how much you pay overall. Here's what you need to know.
What is an origination fee?
An origination fee is what a lender charges for the administrative costs of providing the loan for the borrower.
"Some lenders will break that down into one fee. And some lenders will break it down into separate items, such as an underwriting fee, a processing fee, or preparation fee," said Donna Snow, a mortgage lender for Regions Bank.
For a mortgage, the origination fees can be found in the top left-hand corner of Section A on page two of your Loan Estimate.
Lenders are required to send your Loan Estimate within three business days of receiving your application. And while certain parts of your final Closing Disclosure could differ from your Loan Estimate, generally the origination fees must stay the same.
How much does a loan origination fee cost?
Many mortgage lenders charge a flat origination fee. For example, Snow said that Regions Bank currently charges a flat $1,397 for its origination fee. Other mortgage lenders may charge a percentage of the loan amount, generally 1% or less.
For personal loans, however, you could pay 1% to 8% of your loan amount in origination fees. The percentage that you're charged for a personal loan origination fee can depend on a variety of factors, including:
- Your credit score
- Your income
- Your loan amount
- Your loan length
- You need a co-signer
Some personal loan lenders allow for the origination fee to be deducted from your loan amount.
For example, let's say you need to take out a $20,000 personal loan to pay for a medical bill and the loan comes with a 5% origination fee ($1,000).
If the origination fee is deducted from your loan, your actual payout will be only be $19,000 ($20,000 - $1,000). So if the full $20,000 is needed for your medical bill, you'd need to take out a slightly larger loan.
Should you buy discount points?
"With mortgages, a borrower can also pay a point, or a fraction of a point, to buy down their interest rate," said Snow. These are often referred to as discount points.
One discount point will generally cost you 1% of your total amount. So for a $200,000 mortgage loan, one discount point would raise your origination fee by $2,000 (1% of $200,000). And two discount points would raise your origination fee by $4,000 (2% of $200,000).
You can typically expect to earn a 0.25% interest rate deduction for every point that you pay. So if you were originally quoted an interest rate of 4.50%, paying for two discount points could drop your rate by 0.50% to a flat 4.00%.
If you're trying to decide whether or not paying discount points would be worth it, consider how long you plan to stay in your home.
For example, let's say you paid $2,000 for a discount point and your lower APR will save you $50 per month on your mortgage. In that case, it will take you 40 months to break even on the decision ($50 x 40 months = $2,000).
The longer you plan to stay in your home, the more rewards you'll get out of paying for discount points. But short-term homeowners may want to stick with their original quoted rate.
What about lenders that don't charge origination fees?
A common marketing tactic in the lending industry is to advertise loans that come with "no origination fees." But before you get too excited, make sure that you're not paying for the lender's services in other ways.
"The main concern with these lenders," said Snow, "is that they may be charging a higher interest rate than a competitor. They simply absorb their cost in the rate."
That's another reason why it's important to shop around with multiple lenders before you take out a loan.
"You can take a loan estimate from one lender to your own bank and see if they can match it," Snow explained. So don't be afraid to give lenders a chance to compete against one another.
The bottom line
While origination fees are important, they need to be considered in light of other loan factors. For example, it may be worth it to pay a higher origination fee to secure a fixed interest rate on your loan as opposed to a variable rate.
Above all, don't allow lenders to rush you into making a quick decision. Take your time comparing loan offers. And always consider how the origination fee will affect what you pay over the life of the loan.
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