When you’re in the market for a mortgage, there are many factors that go into choosing the appropriate loan and lender for your situation. One thing you need to be aware of when shopping around are the kinds of fees the lender is charging, one of which is the origination fee.
The purpose of this article is to give you an overview of what the origination fee is so that you have a better understanding of what you’re getting when you shop around for a mortgage. A knowledgeable purchaser is more equipped to navigate the home buying process.
What Is An Origination Fee?
An origination fee is what a lender charges in order to set up the loan. Some lenders split this into a processing fee (the cost of taking your application and gathering documentation) and an underwriting fee (the cost to have someone look at your application and determine if you qualify). For others, this is one fee.
You may think that a lender makes money off the interest charged with each monthly payment, but this is increasingly not the case. Most mortgages are sold shortly after closing to one of the major mortgage investors who then makes them available on the bond market. This provides easy liquidity rather than lenders having to wait 30 years for the loan to pay off. The money a lender makes is generally based on the origination fee and any money collected by servicing the loan – taking your payment and handling the escrow account.
How Does An Origination Fee Work?
An origination fee is charged based on a percentage of the loan amount. Typically, this range is anywhere between 0.5% – 1%. For example, on a $200,000 loan, an origination fee of 1% would be $2,000.
You may see a loan advertised as having no origination fee. However, if you’ve been around the block at all, you understand that there’s no such thing as a free ride. The lender makes its money by charging a slightly higher interest rate, which can fetch more money when the loan is sold to mortgage investors. Making money off a higher interest rate is referred to as having a bigger yield spread premium.
With a no-origination fee loan, you’ll pay less upfront in closing costs, but you’ll pay more in interest over the lifetime of the loan. It comes down to what’s important to you.
Assuming you do end up with an origination fee, it’s paid at closing along with other fees such as your down payment and title costs. It’s important that you budget for these items early on.
Origination fees are typically intended to cover a range of miscellaneous lender costs including the processing of your loan application, the cost of underwriting the loan, which involves verifying everything from your income and assets to your job history, and preparing your mortgage documentation.
Cost Of Origination Fees
Most of the time, origination fees are a percentage of the loan amount. It’s usually 0.5% – 1% for U.S. mortgage loans. For lenders that split up underwriting and processing fees, add the percentages together to be sure you’re comparing apples to apples. Additionally, this is just one component in your overall closing costs. In order to get a better idea of the fees being charged by lenders for comparison purposes, be aware that lenders always have to publish two rates: the base interest rate and the annual percentage rate. The annual percentage rate includes the base interest rate plus closing costs associated with your loan. The bigger the difference between the base rate and the annual rate, the more the lender is charging in closing costs and fees.
Ways To Minimize Origination Charges
Although the lender is going to make its money somehow, it’s worth noting that there are ways you can cut down on both origination fees and overall closing costs.
Sometimes if a lender wants your business, the fee may be more negotiable. If a lender has a reasonable suspicion your loan is going to close and you could go with anyone else and have them lose out on the business, you have more room to negotiate. If you have great credit, assets and income, a lender may be willing to cut into their margin a little bit in order to earn your business.
Another strategy you can use is to shop around and compare lenders. You would do this using the APR in order to look at the total cost of loan options. When shopping around for different interest rates, make sure the loan options are the same. The rate would be different on a 30-year fixed than it would be on a 5-year adjustable rate mortgage.
Mortgage lenders offering you the chance to buy points in order to get a lower interest rate in exchange for higher closing costs. One point is equal to 1% of the loan amount, but you can buy points in increments down to 0.125%. You can do the same thing in reverse to lower your closing costs by taking lender credits.
In exchange for a higher interest rate, you can minimize or even eliminate your closing cost by taking negative points. One thing to note is that you’ll pay more on the loan over time this way, so taking negative points makes the most sense if you’re going to be in the house for a short amount of time.
Think About Seller Concessions
If you’re buying the property and moving into a new home, you can sometimes negotiate with the seller to get them to pay for certain closing costs which may include your origination fee. Seller concessions have to be included as part of your purchase agreement to utilize this strategy.
There are a couple of drawbacks to this strategy. First, sellers may be more hesitant to take your offer if it requires them to pay a bunch of fees. Additionally, they may actually be limited in the amount they can give you, as all major loan programs have upper limits on how much sellers can pay for in closing costs, expressed as a percentage of the overall loan amount.
Consider Gifted Funds
You can get a gift from a family member to cover your closing costs, including your origination fee. In addition to family members, some loans allow you to get gifts from nonprofit organizations, close friends, labor unions, employers or government agencies.
One thing to note about this approach is that it has to be a gift, meaning they’re required to put in writing that you don’t have to pay it back. The lender may also require certain proof of funds in the account and the transfer.
Pay Up Front
If you can afford it, it’s best to pay your closing costs, including your origination fee, upfront if you can. This has a couple of advantages.
First, you know exactly how much you’re spending on your closing costs rather than thinking of it as some unknown higher number paid out over the course of the loan term. You’ll also get a lower rate when you pay your closing costs upfront rather than building them into the interest payment. This makes a lot more financial sense if you can do it.
Now that you have a better understanding of origination fees, you can go about your mortgage shopping experience with that much more savvy. To get started, you can apply online or give us a call at (800) 785-4788.