Loan origination costs: everything you need to know

When you take out a loan, you may have to pay back more than just the principal and interest. Some lenders also charge an origination fee, an upfront fee for processing a new loan application, including underwriting and verifying new borrowers.

These fees can add hundreds of dollars in additional costs to your loan. The exact amount you pay will depend on your credit status and your overall financial profile. Do your research, compare loans with and without origination fees, and run the numbers to determine which option is most ideal for your financial situation.

What is an origination fee?

An origination fee, also called administration or application costs, is a common amount when you borrow a personal loan. It is a percentage of your original loan amount and lenders charge this to cover the costs of processing your application.

If you can’t avoid the cost of taking out a loan, you can usually pay it back in two ways: adding the cost to your loan balance or taking it out of the money you receive.

Greg McBride, Bankrate’s chief financial analyst, says deducting the fee from the loan principal may be the only way some people can afford a personal loan. “For many borrowers, it is much more convenient to have it come from the loan proceeds, simply because they may be tight on cash initially.”

How are loan origination costs determined?

The amount you pay in fees is determined by factors such as:

• Your credit score.
• Your belongings.
• Your obligations.
• Your total income.

Not all loans have origination fees, but don’t assume these offers are always the cheaper choice. If you are considering a personal loan without origination fees, pay close attention to the other costs of the loan.

Lenders still need to make money, so they may instead try to recoup their money through higher interest rates or prepayment penalties. In some cases, a loan with an origination fee can still have a lower overall cost. Always use a personal loan calculator and compare lenders based on the annual percentage rate (APR), not the interest rate, to determine which has the best offer.

Example of an origination fee

Lenders set origination fees between 1 and 10 percent of the loan amount, although some lenders charge an origination fee of up to 12 percent. So if you borrow a $10,000 personal loan with a 5 percent origination fee, you’ll receive $9,500 from your lender.

You can use this knowledge to your advantage when applying for a job. For example, if you know that you need exactly €10,000, you can request a slightly larger amount. This way you don’t have to worry about not reaching your actual financing goal.

Unlike a late fee, you will not pay the origination fee out of pocket. Instead, it is deducted from your loan before you receive it. If a lender tries to charge you an origination fee before you receive your loan, it is a sign of a personal loan scam.

Should you consider a loan if there is an origination fee attached?

For lenders that charge origination fees, those fees are mandatory loan fees, although you may be able to negotiate a lower rate. However, origination fees aren’t always a deal breaker. For example, origination fees on a loan can mean a lower overall interest rate because lenders without origination fees can raise their interest rates to make up the difference.

The origination fee is only a small part of determining your total loan costs. For example:

• Your credit score: The biggest factor affecting loan rates is probably your credit score. Someone with a good credit score (670 and above) is more likely to get a lower interest rate than someone with poor credit.
• Type of loan: With a variable rate loan, your interest rate can change over time based on market interest rates. The opposite is true with a fixed-rate loan, meaning your payment amounts won’t change.
• Your location: Loan rates vary depending on where you live, but if you choose to work with a national bank or online lender, this will play less of a role in your costs.

Therefore, you need to calculate the total cost to determine whether the origination fee will increase the cost of the loan.

That said, the origination fee is often deducted from your loan proceeds, meaning you may not receive your full loan amount. Still, the benefits of taking out a loan with an origination fee can far outweigh the fee itself.

How do you compare loans with an origination fee?

Comparing loans with an origination fee can help you save money over time and ensure you get the best deal possible.

1. Get multiple quotes

As with any loan, it’s important to shop around to make sure you’re getting a good interest rate. Look at the best rates on personal loans and find a lender that can give you what you need. Ask your lender if there will be an origination fee and review the full terms of your loan to avoid hidden fees.

2. Look at the APR

The annual percentage rate on your loan is based on the interest rate, but also takes into account other costs, including loan origination fees. When you calculate the total cost of repaying your loan, you should not include the origination fee on top of the APR. If you do, you’ll likely estimate higher costs than what you would pay.

For example, let’s say you’re comparing personal loans from two lenders. Both offer 10 percent interest and a five-year term. However, the first loan offer carries a 3 percent origination fee, while the second carries a 5 percent fee. The interest rate remains the same for both loans, but the APR for the first loan will be significantly lower than that of the second.

3. Consider the length of your loan

In general, the shorter the term of your loan, the lower your interest rate will be. However, shorter loans tend to have higher monthly payments. If the origination fee is paid on top of the interest and principal, you may be more inclined to choose a loan without an origination fee, or a loan where the costs are deducted from the loan amount to keep costs low.

How can you save on origination costs?

Loans often come with origination fees to help lenders make money, while offering incentives to the borrower in the form of lower interest rates and other fees that may be included. One of the best ways to save on origination costs is to get estimates from lenders who don’t include them in their loans. Credit unions often have membership requirements to join, but they also typically do not charge origination fees.

Another way to save on origination fees is to negotiate the amount owed. You may not succeed, but it doesn’t hurt to try. If a lender knows that you can choose another option if the fee is not reduced or waived, it may be enough to make him or her reconsider.

The bottom line

Origination fees are not a guaranteed cost when you borrow a personal loan, but they are very common. If you don’t have excellent credit, it’s likely that the lenders you qualify for will charge at least a small fee.

Because the average interest rate on personal loans is over 12 percent, it is crucial to compare lenders based on total costs. Use the loan’s annual percentage rate, not the simple interest rate, when determining which option is best for you.