Lender fees, even small ones, can add to your total cost of borrowing for mortgage, personal or other loans. Watch out for origination fees, in particular.
Here's what you need to know about origination fees, how they can influence loan costs and when you should -- or shouldn't -- pay them.
What Is an Origination Fee?
"An origination fee is a common fee that's added to consumer, commercial and mortgage loans," says Ashley Luethje, sales manager at Waterstone Mortgage in York, Nebraska. "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."
Depending on the type of loan, an origination fee may cover the costs of preparing loan documents, underwriting the loan and processing the loan application, Luethje says. A mortgage origination fee, she says, will be about 1 percent of the total loan amount, "but with consumer and commercial loans, this percentage amount can be greater and is at the discretion of the lender."
[Read: Best Mortgage Lenders.]
Following Luethje's 1 percent estimate, a $300,000 mortgage loan would have an origination fee of $3,000. For personal loans, origination fees can vary widely, and you could pay between zero and 6 percent, based on the lender.
The type of loan also determines how you pay an origination fee. With a mortgage loan, the origination fee is usually paid as part of your closing costs, which include other fees, such as a credit check fee, attorney fees, mailing fees and fees for discount points, if you're paying those.
With a personal loan, some lenders allow borrowers to pay the origination fee upfront, or it may be taken directly from your loan proceeds. In the latter case, if you borrow $30,000 and pay a 2 percent origination fee, $600 goes to the lender to cover the fee, and the remaining $29,400 comes to you.
Do All Loans Have Origination Fees?
The short answer is no. Although origination fees were once customary for mortgage loans because they resulted in revenue for lenders, they are now at your lender's discretion, says David Linn, president of Quintessential Mortgage Group in White Plains, New York. Some mortgages are available without an origination fee, but you could pay a higher interest rate.
Origination fees for personal loans, auto loans and private student loans are, likewise, 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're taking out federal student loans. The fee you pay hinges on the type of loan and when the loan is disbursed to you.
For example, a loan fee of 1.062 percent applies to direct subsidized and unsubsidized loans disbursed from Oct. 1, 2018, to Sept. 30, 2019. The fee for Direct PLUS loans disbursed in the same time frame climbs to 4.248 percent. The origination fee for federal student loans is deducted from the loan proceeds, with the remainder paid to you or your school to cover education costs.
What Happens When a Loan Has No Origination Fee?
Origination fees are just one way a lender makes money on a loan. When a loan doesn't have an origination fee, the lender may try to compensate for that by charging other fees.
With mortgage loans, Linn says, an origination fee may be replaced with operational fees, such as:
-- Rate-lock fees, which you pay to lock in your approved interest rate for a set period of time.
-- Commitment fees, which apply when your lender commits to extending you credit.
-- Underwriting and processing fees to finalize your loan paperwork and fund the loan.
[Read: Best Small Business Loans.]
"Consumers are often so focused on avoiding the larger fees, like origination fees, that they ignore the other costs, which can sometimes be significantly higher," Linn says.
However, these fees may apply, even if you pay an origination fee, so scrutinizing all the fees involved in your loan is always a good idea.
Aside from swapping origination fees for other fees, lenders -- mortgage or otherwise -- can offset the lack of an origination fee by charging borrowers a higher annual percentage rate.
"Lenders have the option not to charge an origination fee, which we sometimes see as a tactic used to generate additional business," Luethje says. Consumers might perceive a loan without an origination fee as less costly, even if the overall cost is greater, and borrow more money.
"With 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 in order to pay for the production of the loan," Luethje adds.
For a larger loan, a higher APR can add significantly to the overall cost of borrowing. 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 percent origination fee and has a 9.99 percent APR.
-- Loan B has no origination fee but comes with an APR of 11.99 percent.
Both loans have a five-year repayment term. If you choose Loan A, you'll pay a $5,000 origination fee and $68,632 in interest over the life of the loan. If you choose Loan B, you can avoid the $5,000 origination fee, but your total interest climbs to $83,591. Loan B saves you $5,000 on the fee but costs you nearly $15,000 more in interest.
When Should You Choose a Loan With No Origination Fee?
At first glance, a loan without an origination fee might seem like a better option, especially if you're considering a business or personal loan, and the fee may be deducted from your loan proceeds. When there's no fee to pay, you're receiving the full loan amount you were approved for. Making sure you get every penny of the loan may be important if you're funding a large-scale business investment, consolidating high-interest credit card debt or financing a major home renovation project.
As the previous example illustrates, however, skipping out on an origination fee can end up being expensive. Luethje says borrowers must choose whether to forgo the fee based on their needs.
"If an upfront origination fee hinders your ability to receive a loan, but a higher interest rate is a better option, then that might be the best scenario for you as a consumer," she says.
Borrowers need to do a little digging when a loan has no obvious origination fee, Luethje adds. "Is the fee being charged somewhere else, or is it truly not being charged?" she asks. "If it's not being charged, absolutely, take a loan without an origination fee. Just be cautious, and make sure it's not being added somewhere else to compensate the lender."
[Read: Best Personal Loans.]
When Should You Pay a Loan Origination Fee?
If you're unsure of whether to pay an origination fee, Linn says, consider whether doing so could help you achieve your primary goal in taking out a loan.
"The most obvious case where an origination fee makes sense is when it helps as a means to an end," he says.
With a mortgage loan, paying an origination fee could result in a lower interest rate, which could also lower your payment. A lower payment could lead to a lower debt-to-income ratio, or the percentage of your income that goes toward debt repayment each month.
As you weigh your decision, also consider your time frame. For shorter-term loans, paying an origination fee may not yield much of a benefit because you have less time to recoup the fee through lower interest costs. On a 20- or 30-year mortgage loan or a 10-year business loan, however, you have more of an advantage when it comes to saving on interest if paying the origination fee provides a lower APR.
Compare Loan Origination Fees and Rates Carefully
Obtain rate and fee quotes from multiple 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 focus solely on 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."
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