Loan origination fees are a commonly misunderstood type of fee associated with mortgages and other types of loans. Many borrowers don’t understand what the fee is intended for or whether it’s necessary. That’s OK; it’s never too late to learn. This line item is an important fee to understand when comparing loan offers or deciding whether to take out a loan.
Let’s take a look at what loan origination fees are, what they pay for, and how loans without this fee aren’t always the best deal for your needs.
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When you apply for a mortgage or other loan, you’ll likely notice several fees listed as line items in the paperwork, depending on the type of loan.
Some fees are charged by the bank for services rendered. Other companies involved in the process charge third-party fees, such as title insurance fees or appraisal fees. These fees cover various costs of the loan process. While some fees have self-explanatory names, others refer to industry terms like loan origination that may not be as well understood.
Loan origination is the process of creating a loan or mortgage. Loan origination is everything from the time you apply and submit financial information to the time the lender funds and distributes the loan.
A loan origination fee is charged by the lender to cover the costs of originating the loan. These costs can include, depending on the type of loan:
- Preparing and processing paperwork
- Arranging for necessary services and scheduling appointments
- Collecting needed documentation
- Credit and income checks
- Underwriting the loan
Loan origination fees are commonly assessed as a percentage of the total loan amount. The average loan origination fee is usually between 0.5–5% depending on the type and amount of the loan.
Note that this is a separate fee from other fees that lenders commonly assess during a loan. For example, when taking out a mortgage, some lenders will allow the borrower to buy ‘discount points.’ This means you pay an upfront fee in return for a lower interest rate. Another common fee is the application fee, which lenders often apply to checking the borrower’s credit.
Some lenders take the opportunity to stand out from others by waiving the loan origination fee or allowing consumers to negotiate it out of a loan deal. They advertise that they don’t charge an origination fee, often perceived as a savings for their customers. But it’s not really a savings if they gain the money back somewhere else.
The truth of the matter is that the costs of loan origination must be paid somehow. Lenders have to recoup their expenses and make at least a modest profit or they won’t continue to offer loans. Generally, if a bank is waiving the loan origination fee, they’re making that fee up elsewhere, either through different fees or a higher interest rate.
Recent research has shown that Americans value transparency and fair business practices more than ever before. The internet makes it easier to research and be a knowledgeable consumer, and that’s led to a preference for transparency and clarity in purchasing. Lending platforms such as Prosper favor fair and transparent fees. Transparency is just good business.
One last thing to consider is the purpose of the loan. Mortgage loan origination fees are often tax-deductible. Personal loan origination fees are sometimes tax-deductible, depending on the purpose. If you’re using a personal loan for qualifying business or educational expenses, these fees may also be deductible from your taxes. This is subject to changing tax laws and may vary by state. We recommend consulting with your accountant or tax preparer for more information.
If you’re taking out a loan, remember to look at the whole picture to determine the cost of the loan. While an offer to waive the loan origination fee may be enticing, it’s essential to look at the interest rate and all the fees associated with the loan to see the actual total cost. Chances are, waiving the loan origination fee just means they’re making the money back somewhere in a less obvious fashion. Transparency is important when making major financial decisions.
Take, for example, a personal loan through Prosper. Prosper’s unique peer-to-peer lending model provides easy access to credit for many consumers, and the loan origination fee covers the actual costs of offering and servicing the loan. In addition, loans through Prosper reflect commitment to transparency including representing fees up-front, with no hidden “gotchas.”
When you add up all the costs of a loan, you’ll often find the loans with the most transparency about their fees and costs end up being the best deal.
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