When funding your mortgage loan, a mortgage lender makes a judgement on your qualifications before taking a calculated risk. In exchange for giving you a mortgage to buy or refinance a home, lenders charge a variety of fees so that they can make money to provide more home financing to others. One of these fees is a mortgage origination fee.
In this post, we’ll go over the origination fee, how to calculate it and when you pay it. We also touch on why they exist, whether all lenders have origination fees and some of the things you have to look out for when comparing the costs charged by various lenders.
What Is A Mortgage Loan Origination Fee?
A mortgage origination fee is a fee charged by the lender in exchange for processing a loan. It is typically between 0.5% and 1% of the total loan amount. You'll also see other origination charges on your Loan Estimate and Closing Disclosure if there are prepaid interest points associated with getting a particular interest rate.
Also called mortgage points or discount points, prepaid interest points are points paid in exchange for getting a lower interest rate. One point is equal to 1% of the loan amount, but you can buy the points in increments down to 0.125%.
If you're trying to keep closing costs at bay, you can also take a lender credit, which amounts to negative points. Here, you get a slightly higher rate in exchange for lower closing costs. Rather than paying up front, you effectively build some or all costs into the life of the loan.
The origination fee itself can cover a variety of things, some of which may be broken out in your Loan Estimate. It covers things like processing your loan – collecting all the documentation, scheduling appointments and filling out all necessary paperwork – as well as underwriting the loan.
How Much Are Loan Origination Fees?
Typically, a loan origination fee is charged as a percentage of the loan amount. Furthermore, lender origination fees are usually anywhere between 0.5% and 1% of the loan amount plus any mortgage points associated with your interest rate.
To put an actual number to that, let’s say a borrower has a $300,000 mortgage approval. The origination fee would be anywhere from $1,500 – $3,000.
When Do You Have To Pay The Origination Fee?
Mortgage origination fees are usually paid as part of closing costs. It varies widely depending on the details of the transaction, but closing costs typically range anywhere from 3% – 6% of your loan amount.
Why Are Mortgage Origination Fees Assessed?
Every lender has costs associated with originating a loan. Whether that’s the overhead for their business or paying bankers, underwriters and scheduling appraisals. The goal is always to make enough money to be able to provide loans to help more people with their home financing. Origination fees cover some of these costs.
Do All Lenders Charge An Origination Fee?
Not all lenders charge an origination fee, but the majority do as compensation for the services being provided. The origination fee is charged at the discretion of an individual lending institution.
Some lenders make a big deal out of advertising home loans with no origination fee. There’s nothing wrong with this, and it can be good for people who want to save on closing costs. When comparing loan options, you’ll always get a better idea by comparing the APR and. interest rate. If the interest rate isn’t higher, another tactic they might use is to request that fee under a different name than “origination.”
Hidden Costs Of The No Origination Fee Mortgage
If a mortgage truly has no origination fees, you’ll end up paying a higher interest rate over the course of the loan in most cases. A lender must make money somehow. Depending on how long it takes you to pay off the loan, this could cost you up to tens of thousands of dollars over the life of the mortgage. While you’re saving money up front, it could cost you way more in the long run.
Other Fees That Add Up
It’s important as someone buying or refinancing a home to understand that there are various points at which a fee can be charged. While most mortgage fees not related to the interest rate that you would get are closing costs, there are others. Let’s run through them.
Rate lock: When you lock your rate at a certain level, your lender must hedge against the possibility that interest rates rise in the near future. You pay for this privilege in the form of a rate lock fee. The shorter the rate lock period, the cheaper it will be.
Commitment fees: A lender must set aside funds for a loan in advance of when they actually give it out. In exchange for the guarantee of the loan at some point in the future, they charge a commitment fee. This is a hedge against conditions in the market changing. As long as it was approved, this lets the client get the money as long as they close.
Underwriting or processing fees: If you see an underwriting or processing fee instead of an origination fee, it’s an origination fee masquerading as something different. It’s the charge for the lender processing any provided documentation and making sure you qualify for the loan.
Higher Interest Rates
As mentioned before, if there truly is no origination fee – and for the purposes of this discussion, let’s include fees serving a similar purpose that go by a different name in that category – the lender is likely to make up for it by charging you a higher interest rate to make more money on the back end of the loan.
To help you put some numbers to this, let’s look at an example for a 30-year fixed mortgage on the $300,000 example home. It’s also helpful to know that mortgage closing costs are also often talked about in terms of points. One point is equal to 1% of the loan amount.
With a 20% down payment, your loan amount would be $250,000. First, we’ll look at a rate with one point of closing costs. Perhaps by paying one point at closing, the rate you can get is 3.75% in this hypothetical scenario. You would pay $2,500 upfront and $166,804 in interest over the life of the loan with a $1,157.79 monthly payment.
Now let’s look at that same $250,000 loan with no points paid. Let’s say that rate was 4.5%. Your monthly payment becomes $1,266.71 while paying $206,016.76 in interest. In the second scenario, you end up saving $2,500 upfront, but you also pay more than $39,000 more in interest.
Another thing that’s important to know when you opt for a higher monthly payment is that it will make your debt-to-income ratio (DTI) higher because you’re spending more on a monthly basis to make payments on existing debts. This can impact your ability to qualify for other loans in the future, because DTI is a key metric used by lenders.
You don’t want to take on such a high monthly payment that it’s going to hinder your financial flexibility in the future. If you opt for a no-origination-fee loan, it’ll likely come with a higher interest rate leading to a higher monthly payment. This could push your DTI up significantly.
When lenders are speaking to you about their fees, and in some cases their lack of them, it’s important to figure out what you’ll be paying over the life of the loan and weigh the benefits and downsides of a no origination mortgage. One way to do a quick comparison is to look at the interest rate.
When you shop for different interest rates, there are two interest rates you’ll see. The first one is the interest rate your monthly payment is based upon. The second one is called the annual percentage rate or APR and will be higher. This is your interest rate with closing costs accounted for. When comparing loan options, you’ll always get a better idea by comparing the APR.
Conclusion
Although not every lender charges an origination fee, they typically make up for it by charging a higher interest rate on the loan itself, so always be aware of the upsides and downsides. You may be saving money at closing, but paying more in the long run.