Origination Fee

An origination fee is an amount paid by the borrower to the lender at the time the loan is made to cover the cost of processing the loan.

This is a processing or service fee that banks or other financial institutions charge a customer in order to open an account or take out a loan.

What Is An Origination Fee?

Lenders apply an origination fee to a loan to cover the costs associated with its application and approval process. An origination fee is usually calculated as a percentage of the total amount of the loan, and it might vary in size depending on the type of loan.

Lender’s application and approval procedures commonly involve a significant amount of paperwork and time invested by trained professionals to review each application. Additionally, they must be compensated for other operating costs associated with these processes, including utilities, computer systems, and legal expenses. Origination fees help to cover these costs.

Origination fees are expressed as a fixed percentage that is deducted from the total amount of the loan. This fee is usually paid after loan approval, and it’s typically either deducted directly from the loan or collected separately.

For mortgage loans, origination fees often vary from 0.1% to 1%, depending on the lender. Other types of loans may involve a higher origination fee, ranging from 1% to 5%. In most cases, the origination fee also varies depending on the borrower’s credit situation, financial situation, and the type of loan they are applying for.

Which Loans Usually Charge Origination Fees?

Even though a significant portion of the loans available in the U.S. market charge an origination fee, certain credit lines aren’t subject to them. For example, credit cards aren’t usually affected by origination fees.

Traditional loans, such as mortgages, consumer loans, commercial loans, personal loans, and student loans, require an origination fee. However, under certain circumstances, lenders may decide to waive the origination fee.

Is It Possible to Negotiate Origination Fees?

In most cases, lenders will not be inclined to reduce the origination fee. That being said, there’s a small chance that the origination fee can be waived or reduced under certain special circumstances, but that solely depends on each lender’s policies.

On the other hand, borrowers may ask lenders to eliminate the origination fee in exchange for a higher interest rate. This arrangement might or might not be beneficial, as the borrower could end up paying higher borrowing costs.

Borrowers should calculate the resulting costs from each alternative to make sure the outcome is positive.

Furthermore, since origination fees vary from one lender to another, borrowers are usually encouraged to look around to find the cheapest alternatives, considering the interest rate and all applicable charges, to make an informed decision on the matter.

Origination Fees and Their Impact on Borrowing Costs

The annual percentage rate (APR) measures the overall cost of borrowing a loan, including the interest rate and other charges applicable. In most states, lenders are required by law to calculate the loan APRs to inform borrowers about the actual cost of borrowing.

Origination fees increase the loan’s APR, so it must be incorporated into the estimation of the cost of borrowing a loan. The higher the origination fee, the higher the impact it will have on the APR of the loan.

Origination Fees vs. Other Fees

Origination fees are part of a wide range of fees that are commonly applied to loans and credit lines. Some of these fees include:

  • Prepayment penalty fees: Prepayment penalties are charged if the borrower pays for the pending balance of a loan before the end of the entire credit period. They differ from origination fees because they are charged once the prepayment is received, and they are often a fixed amount instead of a percentage-based fee.
  • Late payment fees: Late payment fees are collected or added to the loan’s pending balance if the borrower fails to pay the loan installments on time. They differ from origination fees because they are usually periodical, which means that they are charged after each credit period ends if the borrower is still late on their payments.
  • Application fees: Application fees are collected from prospective borrowers who are looking to obtain a loan. This fixed fee must be paid regardless of whether the loan is approved—unlike origination fees, which is only paid if the loan is approved.
  • Closing fees: Closing fees are similar to origination fees, but they have a different purpose. Origination fees cover the costs associated with the loan’s application and approval process, whereas closing fees are usually related to legal expenses and documentation that must be completed for the loan to be approved.
  • Collection agency fees: If a borrower has been late on their payments for a sufficient amount of time, lenders can send the loan to a collection agency. This company will take care of the retrieval of the payments from that point forward. If this happens, borrowers may be charged with collection agency fees, which are usually added to the loan’s pending balance.
  • Membership fees: This fee is commonly applied to credit cards and other similar credit lines, and they are charged on a monthly or annual basis as compensation for access to an exclusive product or service. They are a recurring fee, which makes them different from origination fees, which are one-time fees.

Origination Fees and Taxes

Origination fees are treated by the IRS as interest paid on a loan, which means that they can be fully deducted from an individual or couple’s income tax.

An origination fee can also be deducted the same year that the loan is taken out in most cases—except when the loan is a mortgage on a property that is not the person’s primary residence. For these cases, the origination fee must be spread throughout the lifetime of the mortgage and deducted accordingly.

Finally, the Tax Cuts and Jobs Act bill of 2017 limited the deduction that individuals and couples can incorporate in their tax returns to $12,000 for individuals and $24,000 for married couples filing jointly.

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