What Is an Origination Fee?
An origination fee is an upfront fee charged by a lender for processing a new loan application. It's compensation for putting the loan in place. Origination fees are quoted as a percentage of the total loan, and they're generally between 0.5% and 1% on mortgage loans in the United States.
Sometimes referred to as discount fees or points, particularly when they're equal 1% of the amount borrowed, origination fees can cover a lot of services in addition to processing, including underwriting and funding.
How an Origination Fee Works
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 it takes a 1% fee for originating that loan. The origination fee represents the primary way in which a lender gets paid for its initial services.
Customers with large loan amounts are often able to negotiate lower origination fees because lenders tend to be willing to make concessions to earn their business. Likewise, the origination fee sometimes represents a higher percentage of the loan amount on less-expensive loans because a $50,000 loan can require the same amount of work from the lender as a $500,000 loan.
You can compare total mortgage fees from lenders easily by using a tool like a mortgage calculator. These fees are typically set in advance and they suddenly increase at closing. They should be listed on your closing disclosure.
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.
Examples of Origination Fees
Lenders often earned exorbitant origination fees and yield spread premiums 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 that charged origination fees as high as 4% or 5% of the loan amount. These lenders made thousands of additional dollars in yield spread premiums.
The government passed new laws following the financial crisis of 2008, limiting 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.
- 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 taking the loan. They shouldn't come as a surprise at the time of closing.
Like many mortgage terms, origination fees can be negotiable, but a lender can't and shouldn't be expected to work for free. Obtaining a reduced origination fee usually involves conceding something else to the lender. The most common way to lower the fee is to accept a higher interest rate in return. Effectively, the lender earns their commission from yield spread premium instead of an origination fee.
As a general rule, this is a good deal for the borrower only if she plans to sell or refinance within a few years.