What is a Loan Origination Fee? Explaining the Basics and How It Affects Your Borrowing Cost

Let me assure you that origination fees aren’t some kind of phantom tax that emerges from the shadows to feast on your money. While not exactly something to celebrate, the fee isn’t nearly as scary as it’s made out to be. It’s just the way a lender covers its costs for lining up your loan. 

A loan origination fee is a reimbursement to lenders for the cost of processing and approving your loan.

I’m going to debunk a lot of myths about origination fees, why lenders charge them, how they’re calculated, and how they impact loan costs over time. Don’t worry, I’ll leave all the wild conspiracy theories at the door.

If you don’t know what an origination fee is when you apply for a loan, you may be about as lost as a CEO at a minimum wage rally. 

When dealing with loans, these fees are what lenders use to grease the wheels for your loan approval, and they can sure sneak up on you if you aren’t paying attention. 

Credit cards don’t charge origination fees, although some subprime cards may have something similar, including application, setup, or activation fees.

The Purpose of Origination Fees

Lenders don’t dole out loans out of the goodness of their hearts. They’re running a business, and businesses cost money. That’s where origination fees come into play. 

These charges help cover the cost of all the paperwork, background checks, and credit reviews lenders use to help ensure you aren’t going to skip out on your payments. 

Lenders have to pay for many types of overhead: salaries, technology to process your information, legal reviews, and other back-office hocus-pocus. 

The fees help them recoup those expenses without waiting for years of interest payments to trickle in.

Don’t get me wrong. I don’t necessarily disagree with people who think these fees are a bit of a racket. But ultimately, lenders must cover their expenses and ensure they aren’t losing money upfront. This is why they tack on origination fees, which can vary depending on various factors.

So next time you see that charge on your paperwork, just know it’s supposed to cover all of the behind-the-scenes action it took to get your loan through the system. Is there a little extra left over after all those costs are paid? Probably.

How Origination Fees Are Calculated 

Lenders typically calculate an origination fee as a percentage of your loan amount. It’s often between 1% and 10% (which is really high). That may not sound like much, but when you’re talking about a large loan, the fee can grow faster than sunflowers after a good rain. 

You are, in effect, paying for the privilege of borrowing money, and that fee gets wrapped right into your loan cost from the outset.

For example, say you borrow $20,000, and the origination fee is 1%. Well, you’d need to pay $200 upfront just for that origination fee. So, instead of getting loan proceeds of $20,000, you would get $19,800 because the lender might subtract the money before you receive it. 

The other option is to have the fee tacked onto your loan principal (and pay interest on it), so you’d take out a loan for $20,200.

Potential Impact of Origination Fee on Personal Loan Disbursal

It’s clear that the more you’re borrowing, the more you’re paying in fees. The percentage remains the same, but the loan is larger, meaning a bigger hit to your wallet. So, if you’re borrowing a lot of money, that origination fee can surely loom large.

Common Types of Loans with Origination Fees 

You are most likely to bump into origination fees when dealing with:

• Personal loans
• Mortgages
• Private student loans

Each loan type has its quirks, but one thing remains constant for all three: if you are borrowing, you are likely forking over that fee. 

Providers of personal loans like to slap on the fee at closing, and you might learn of it until it’s too late to turn back. Mortgages are a different story. On a mortgage, that fee is usually wrapped into your closing costs, and it may be just one of many fees hitting your bank account when you sign on the dotted line. 

The law requires mortgage lenders to disclose all costs well before closing, so you aren’t likely to be blindsided.

Some private student loans have origination fees as well, although these are usually smaller than those for mortgages. Nevertheless, the song is the same — you pay a chunk upfront, which goes to cover the lender’s costs for getting all its ducks in a row. 

Have no doubt that origination fees can dig into your wallet, so it’s mighty important to know how they add to the total cost of a loan or credit card. Whether you’re thinking short-term or long, these fees can cost you way more than just pocket change.

Immediate Financial Impact

Firstly, the origination fee can take a chunk out of your loan before you ever see a thin dime, or it could increase your loan cost by a couple hundred dollars. This is what’s in store for you:

• The lender takes its cut upfront, so you don’t get the full amount of the loan.
• Or the lender tacks it onto your loan amount, which you then have to pay interest on.
• Either way, it’s an extra cost you perhaps weren’t counting on, so your borrowing power takes a hit, or the loan becomes more expensive.
• The usual percentage normally ranges from 1% to 10% of the total loan. But 10% is incredibly high.

Whether you like it or not, that fee’s already sunk into certain loans deeper than a tick on a hound, and there might be no way of escaping its bite.

Inclusion in Annual Percentage Rate (APR) 

Now, here’s where it gets trickier than a Las Vegas magician. Lenders roll the origination fee right into the APR. That APR, in turn, impacts the total cost of your borrowing because you’ll be paying the fee spread over the entire life of the loan. 

Loans and credit cards handle APRs differently. With loans, the origination fee gets factored into the APR upfront, so you see a clear picture of what the loan’s going to cost you over time. Credit cards, though, typically don’t include fees in their APRs. Instead, they charge fees separately from their interest rate.

So, when it comes down to comparing the two, a loan’s APR shows you the total cost, including the origination fee. With a credit card, you may have to pay various charges, including upfront application fees. Still, if you pay off the balance each month, you’ll sidestep the card’s APR entirely.

Comparing Loans With and Without Origination Fees 

Choosing between loans with origination fees and ones without means you will need to do a little investigative work.

Loans without origination fees may look mighty tempting up front, yet they can carry higher interest rates. Meanwhile, loans with origination fees may offer lower interest, but that fee will hit you right away 

Suppose you are comparing two loans that are both $100,000. The first has a 2% origination fee and a 5% interest rate. The second has no fee but a 6% rate. The fee-based loan costs you $2,000 upfront, but the lower interest may save you more in the long run.

No fee sounds nice, but higher interest rates continue to nibble at your budget month after month, like a goat visiting a clover field. You should do the math and see how much you’ll be paying over time, and then choose the one that keeps more cabbage in your wallet.

The range of fees for a loan can be all over the map. Origination fees are just a piece of the puzzle, as loan agreements contain an assortment of other fees. In some cases, the fee list might make your eyes water.

It’s like trying to tell the difference between a donkey and a mule. They may look alike, but they are not the same beast. Understanding the different fees lets you prepare for the day of reckoning when you have to pay them.

When you compare a 1% origination fee with the 5% that a real estate agent pockets, that loan fee starts looking almost reasonable. While the lender’s getting its cut just to handle the paperwork, that real estate agent walks away with a king’s ransom for hooking you up with the seller. 

It sure would be nice to instead use that money toward, say, an extra bathroom or upgraded kitchen cabinets!

Application Fees

Here is where people start to confuse things: Origination fees and application fees are not the same. An origination fee is how the lender obtains money for the cost of setting up your loan after it has already been approved. An application fee, however, is what it charges for considering your loan in the first place.

Origination fees are usually a lot bigger than application fees, but neither one’s doing your bank account any favors. You’ll want to be careful and ask ahead of time whether a lender charges both — they may be shy about volunteering that information.

Let’s say you apply for a personal loan. For processing the application and checking your credit score, the lender charges you an application fee of $50 right off the bat. When giving you the loan, in addition, it will charge an origination fee, which is usually a percent of the loan amount.

You first pay the chance of landing the loan, and then you pay again in case the lender actually gives it to you.

Closing Costs

Origination fees, when dealing with mortgages, are only a part of that beast they call “closing costs.” These costs include all sorts of fees and expenses that pile up higher than a Tame Impala audience when you’re buying a home, including charges for appraisals, title searches, and legal stuff. 

An origination fee might be the Big Kahuna, but it isn’t the only thing draining your wallet before you get the house keys.

For example, say you borrow $200,000. The lender may also charge you a 2% origination fee. That’s $4,000 right there. But then you add in all those other closing costs, like home inspections and legal fees, and you’ll probably be looking at $5,000 to $10,000 in additional costs. That’s a righteous pile of cash just to seal the deal.

The big difference, however, is that origination fees go straight to the lender for setting up the loan, and closing costs cover everything else involved in buying the house.

An origination fee is like paying the DJ at a wedding reception, and other fees are like purchasing drinks for the guests.

Possible Hidden Fees in Loan Agreements

When reading through a loan agreement, you may find a whole platoon of other sneaky fees waiting to pounce. Watch out for these, as some lenders can be pretty slick Here are some candidates for this hall of shame:

• Application fees: Paying just for the privilege of being considered. 
• Prepayment penalties: You’d think paying off early is good; some loans fine you for it.
• Late payment fees: Don’t pay on time, and your bill will pile up faster than your teenager’s excuses for missing curfew.
• Processing fees: Just for handling the paperwork, even in a paperless transaction.
• Annual fees: Many credit cards charge a yearly fee to keep the account alive. 

If you don’t comb the loan agreement as thoroughly as a hound dog sniffing out a trail, those extra fees will surprise you — like a process server lurking behind a flower pot.

Ask questions, get everything in writing, and make sure you aren’t paying more than you bargained for.

Now, before you go trotting off to sign up for that loan, get those origination fees ironed out, or you’ll be scratching your head when it’s time to write checks. Loan fees may look small at first glance, but they have ways of sneaking up on you. Be sure to ask a lot of questions, read that fine print as if your future depended on it (which it might), and don’t let the lender sweet-talk you into thinking you’re getting filet mignon instead of the standard dog chow.

Look for lenders who waive or charge low origination fees; they can spare you from an unwelcome expense. Be it a mortgage, a personal loan, or a student loan, it pays to know from the start what you’ll pay. 

Stay sharp, check with your lawyer or financial advisor, and don’t be afraid to walk if the deal smells fishier than a catfish fry.