An origination fee is an upfront fee charged by a lender for processing a new loan application, used as compensation for putting the loan in place. Origination fees are quoted as a percentage of the total loan and are generally between 0.5 and 1% on mortgage loans in the United States.
An origination fee is similar to any commission-based payment. If a lender takes a 1% fee for originating a loan, it makes $1,000 on a $100,000 loan, or $2,000 on a $200,000 loan. Customers with large loan amounts often negotiate even lower origination fees, since lenders tend to be willing to make concessions to earn their business. Likewise, because a $50,000 loan often requires the same amount of work from the lender as a $500,000 loan, the origination fee sometimes represents a higher percentage of the loan amount on less expensive loans. You can compare total mortgage fees from lenders easily by using a tool like a mortgage calculator.
As of 2016, the origination fee represents the primary way in which a lender gets paid for its services. During the Wild West days of mortgages in the late 1990s to mid-2000s, lenders often earned exorbitant origination fees and yield spread premiums for selling the borrower a higher interest rate than par. In particular, borrowers with marginal credit or unverifiable income were targeted by predatory subprime lenders that charged origination fees as high as 4 or 5% of the loan amount, and then made thousands of additional dollars in yield spread premium.
Following the financial crisis of 2008, the government passed new laws circumscribing how lenders could be compensated, and public pressure provided an additional incentive for lenders to reign in the practices that had made them rich during the housing boom. Origination fees shrunk to an average of 1% or less, and since borrowers in 2016 come armed with much more information about going rates compared to borrowers in 2006, the days of making easy money from yield spread premium are over.
Like many mortgage terms, origination fees can be negotiable. However, because a lender cannot and should not be expected to work for free, receiving a reduced origination fee usually involves conceding something else to the lender. The most common way to lower the origination fee is to accept a higher interest rate in return. Effectively, the lender earns his commission from yield spread premium instead of an origination fee. As a general rule, this is a good deal for the borrower only if the borrower plans to sell or refinance within a few years. Otherwise, the borrower is better off paying a higher origination fee in exchange for a lower interest rate, as the interest savings over time exceed the origination fee.