What Is an Origination Fee?
A mortgage origination fee is an upfront fee charged by a lender to process a new loan application. The fee is compensation for executing the loan. Loan origination fees are quoted as a percentage of the total loan, and they are generally between 0.5% and 1% of a mortgage loan in the United States.
Sometimes referred to as “discount fees” or “points,” particularly when they equal 1% of the amount borrowed, origination fees pay for services such as processing, underwriting, and funding.
Key Takeaways
- An origination fee is typically 0.5% to 1% of the loan amount and is charged by a lender as compensation for processing a loan application.
- Origination fees are sometimes negotiable, but reducing them or avoiding them usually means paying a higher interest rate over the life of the loan.
- These fees are typically set in advance of the loan execution, and they should not come as a surprise at the time of closing.
Understanding Origination Fees
An origination fee is similar to any commission-based payment. A lender would make $1,000 on a $100,000 loan—or $2,000 on a $200,000 loan—if the lender charged a 1% fee for originating the loan. The origination fee represents payment for the lender’s initial services. It sometimes represents a higher percentage of the loan amount on smaller loans, because a $50,000 loan can require the same amount of work for the lender as a $500,000 loan.
Total mortgage fees from lenders can be compared using a mortgage calculator.These fees are typically set in advance, and they suddenly increase at closing. They should be listed on the closing disclosure.
History of Origination Fees
Lenders often earned exorbitant origination fees and yield spreadpremiums (YSPs) during the late 1990s to mid-2000s for selling the borrower a higher interest rate. Borrowers with marginal credit or unverifiable income were particularly targeted by predatory subprime lenders. These lenders often charged origination fees as high as 4% or 5% of the loan amount, and they made thousands of additional dollars in YSPs.
The government passed new laws following the 2007-08 financial crisis. These laws limited how lenders could be compensated. Public pressure provided an incentive for lenders to rein in the practices that had made them rich during the housing boom. Origination fees shrunk to an average of 1% or less.
A borrower is often better off paying a higher origination fee in exchange for a lower interest rate because the interest savings over time will exceed the origination fee.
How to Save on Origination Fees
Mortgage origination fees can be negotiable, but a lender cannot and should not be expected to work for free. Obtaining a reduced origination fee usually involves conceding something to the lender. The most common way to lower the fee is to accept a higher interest rate in return.
Effectively, the lender earns its commission from the YSP instead of the origination fee. This is executed through something called "lender credits." They are calculated as negative points on a mortgage. As a general rule, this is a good deal for borrowers only if they plan to sell or refinance within a few years because on longer mortgages what you cumulatively pay in interest will generally outstrip what you would have paid in an origination fee. In the case of the latter, consider working with one of the best mortgage refinance companies to ensure you're getting a good deal.
You can negotiate to have the home seller pay your origination fees. This is most likely to happen in the event that either the seller needs to sell quickly or is having trouble selling the home. You can also negotiate with the lender to have the origination fee reduced or waived. This may not involve accepting a higher interest rate if, for example, you have shopped around and can present evidence of a better offer from a competing lender.
Also, if the mortgage is for a large amount and long term and you have excellent credit and a safe source of income, a lender may find your business attractive enough to go easy on fees.
Finally, always make sure to look at what exactly constitutes the origination fee. Some lenders bundle other fees, such as application and processing fees, into it. If that is the case, ask to have those bundled fees waived.
How to Pay Loan Origination Fees
Origination fees may represent just a small part of the closing costs and fees that must be paid when entering into a loan. Specific to a mortgage, there may be a variety of ways to pay this small cost. Note that the ways to cover the origination fees below are not exhausted or listed in any particular order.
- Upfront Payment: Borrowers can choose to pay the loan origination fees upfront at the time of closing. This involves writing a check or making an electronic payment to the lender to cover the fees in full.
- Rolling into the Mortgage: Another common method, borrowers may have the option to add the loan origination fees to the total loan amount. This increases the principal amount borrowed. By doing this, the borrower can spread out the cost over the life of the loan, but it will also increase the total loan amount and, subsequently, the monthly mortgage payments; an example of this is shown towards the end of the article.
- Seller Contributions: In some cases, the seller of the property may agree to contribute a portion or all of the loan origination fees as part of the negotiation process. This is known as a seller's concession and can help reduce the borrower's out-of-pocket expenses at closing.
- Lender Credits: Some lenders may offer lender credits as an incentive to borrowers. These credits can be applied toward covering the loan origination fees or other closing costs. However, lenders offering credits may often charge a slightly higher interest rate in exchange for these benefits. In addition, the credits could have gone towards other costs, so note that this means the origination fees weren't necessarily waived.
- Builder or Developer Incentives: If the loan is for a new construction home or a property being developed by a builder, the builder or developer may offer incentives to cover a portion of the loan origination fees to attract buyers.
- Closing Cost Assistance Programs: Depending on the borrower's financial situation and location, there may be closing cost assistance programs available. These programs may offer grants, low-interest loans, or other forms of financial aid to help cover loan origination fees and other closing costs.
- Negotiation with the Lender: Borrowers can try to negotiate with the lender to reduce or waive some of the loan origination fees. This can involve shopping around for multiple lenders and using competing offers as leverage during negotiations. Note that in competitive environments, it may be difficult to have the entire origination fee waived.
Loan Origination Fees vs. Points
Discount points and loan origination fees are two charges associated with mortgages or home loans representing different aspects of the loan process. Lenders may come across both as part of their purchase and financing documents.
Points are upfront fees paid to the lender at the time of closing the mortgage expressed as a percentage of the total loan amount. There are two types of points: discount points and origination points. Discount points are optional fees borrowers can pay to reduce the interest rate on the loan. Origination points are fees charged by the lender for processing the loan application and creating the loan, essentially compensating for their services.
Loan origination fees are different. They are specific charges imposed by the lender for processing the loan application and facilitating the mortgage process. Loan origination fees may be a flat fee, usually expressed in dollars, rather than a percentage of the loan amount. These fees are meant to cover administrative costs, paperwork, and other services involved in evaluating the borrower's creditworthiness.
Example of Origination Fee
Larry is purchasing his first home and has secured a mortgage through a local bank. The loan amount is $250,000, and the lender charges a loan origination fee of 1.5% of the loan amount. This means the origination fee would be 1.5% of $250,000, which equals $3,750. Even though we discussed many more options above, let's assume Larry only two options in this example:
- Option 1: Pay the Loan Origination Fee Upfront. In this scenario, Larry decides to pay the loan origination fee upfront at the time of closing. He writes a check for $3,750 to cover the fee. By paying the fee upfront, it does not impact the loan amount or his monthly mortgage payments.
- Option 2: Roll the Loan Origination Fee into the Mortgage. Alternatively, Larry can choose to roll the loan origination fee into the mortgage. Instead of paying $3,750 upfront, he requests to add this amount to the total loan amount. As a result, the new loan amount becomes $250,000 (original loan) + $3,750 (loan origination fee) = $253,750.
Assuming Larry opted for a 30-year fixed-rate mortgage with an interest rate of 4%, Larry's monthly payment for a $250,000 loan over 30 years is approximately $1,193. However, with the increased loan amount of $253,750, the new monthly payment would be approximately $1,208. By rolling the $3,750 loan origination fee into the mortgage, Larry's monthly payment increases by $15.
While this may not seem like a significant increase, it's essential to consider the long-term impact, as he will be paying this additional amount over the entire loan term (360 months).
Are Loan Origination Fees Negotiable?
Yes, loan origination fees are often negotiable. Borrowers can try to negotiate with lenders to reduce or waive some of the origination fees. Shopping around for multiple lenders and obtaining loan estimates can provide leverage during negotiations.
Can I Roll Loan Origination Fees into My Mortgage?
In some cases, borrowers can include loan origination fees in the mortgage amount. This means the fees will be spread out over the life of the loan, but it also increases the total loan amount and the overall interest paid over time. It's essential to discuss this option with the lender and understand the implications before proceeding.
Do Loan Origination Fees Vary Depending on the Type of Loan?
Yes, loan origination fees can vary depending on the type of loan and the lender's policies. Different loan programs such as conventional mortgages, FHA loans, VA loans, or jumbo loans may have different origination fee structures.
Are Loan Origination Fees Tax-Deductible?
In most cases, loan origination fees are not tax-deductible. However, some points paid as part of the loan origination process may be tax-deductible if they meet certain conditions. It's essential to consult with a tax advisor or tax professional to understand the tax implications specific to your situation.
The Bottom Line
Origination fees are upfront charges imposed by lenders when obtaining a loan, such as a mortgage. They cover the cost of processing the loan application, underwriting, and preparing necessary documents for closing. Origination fees can be expressed as a percentage of the loan amount or a flat fee, impacting the borrower's upfront costs. Alternatively, they may also be commonly rolled into the mortgage, increasing the total loan amount and monthly payments.
