What is an Origination Fee on a Personal Loan?

When taking up a personal loan, lenders often charge an upfront origination fee. This type of fee may also be known as the underwriting fee, processing fee, or administrative fee, and lenders use it to cover the cost of processing the loan application. You can save hundreds of dollars if you know what is an origination fee on a personal loan and how to avoid paying it.

Keep reading to know how to browse loan offers and negotiate with your lender to get the best loan deal.

How much is a personal loan origination fee?

Lenders charge origination fees based on the work they have to put into processing and disbursing your loan application. These initial services include scouting for loan proposals, gathering documents, checking creditworthiness, verifying documents, underwriting and funding services, and other administrative services for sanctioning loans.

Lenders follow different pricing models for origination fees based on minimum cost averaging of all their loan products. Origination fees can be zero, fixed, or charged as a percentage of the loan amount as processing fees. To avoid confusion on how to calculate loan origination fees, lenders usually charge a uniform percentage of the total loan amount as origination fees. Lenders set the origination fee to cover the administrative costs of processing the smallest loan size. Regulation Z in the Truth in Lending Act regulates these service charges and protects the interest of borrowers.

Your lender will charge you the origination fee upfront. You can find the origination fee on the HUD-1 Settlement Statement, Loan Estimate, or Closing Disclosure. You can pay it from your pocket or adjust it from the loan amount. Hence, you may add the origination fee to your required loan amount to cover the shortfall. For example, if you apply for a $10000 loan with a 5% origination fee, the $500 fee will be deducted from your loan amount, and you will receive $9500. Note that you need to pay interest on the entire $10000.

Let us understand how to calculate loan origination fee and how it affects the final APR of a personal loan.

Case 1 

Loan Amount $10000
Origination Fee 5%
Interest Rate 10%
Repayment term 4 years 
Origination Fees to be paid upfront 5% of $10000= $500
APR 12.74%
Monthly Payment $253.63

Case 2

Loan Amount $50000
Origination Fee 2%
Interest Rate 14%
Repayment term 4 years 
Origination Fees to be paid upfront 2% of $50000= $1000
APR 15.10%
Monthly Payment $66,583.32

Case 3

Loan Amount $50000
Origination Fee 2%
Interest Rate 14%
Repayment term 1 year
Origination Fees to be paid upfront 2% of $50000= $1000
APR 17.87%
Monthly Payment $54,872.31

Case 4

Loan Amount $100000
Origination Fee $1000 Fixed
Interest Rate 13%
Repayment term 4 years
Origination Fees to be paid upfront Fixed= $1000
APR 13.54%
Monthly Payment $129,772

 

Average personal loan origination fee in the US

The average personal loan origination fee in the US is 1-8% for a 2-year repayment period. The rate is standard for low-value loans but flexible in the case of high-value loans. Federal Direct PLUS Loans charge a 4.22% origination fee. Lenders often provide discounts on origination fees based on the loan amount, credit score, job security, collateral, and the loan term.

What factors affect the fee size?

Since the work required is constant for a specific type of loan, in some cases, lenders may charge you more in origination fees than their actual service costs. Origination fees also depend on the lender’s size and specialization. Companies with a technological edge in processing personal loans may offer a genuine discount on loan origination fees. You can get the best origination fee by understanding the factors affecting loan origination fees.

Size of Personal Loans

Since the origination fee is charged as a fixed percentage of the loan amount, you may pay more in originating fees for a larger credit. Comparing Case 1 ($10000 borrowed on 5% origination fees) and Case 2 ($50000 borrowed on 2% origination fees) from the examples mentioned above, you will see that a lower origination fee was paid in Case 1 ($500) than Case 2 ($1000) even though the origination fee is more. If you want a larger sum of personal fees, you may want to scout for loan estimates with low fixed origination fees or lenders willing to negotiate.

Creditworthiness

Lenders prefer borrowers with high creditworthiness and may offer discounts to attract them. If you have a high credit score, you may pay less origination fees. You can include a co-borrower with good credit history to negotiate for a better average origination rate. If you are willing to offer liquid collateral against your personal loan, you can get better offers at both the interest rate and applicable fees.

Loan Term

Note that the APR in Case 2 (4 years) is almost 3% lower than the APR in Case 3 (1 year) solely due to the loan term since the loan amount and lender origination fee is kept constant. So, if you are looking for a long-term personal loan, you may actually find a higher origination fee cheaper in the long run.

How to avoid origination fees?

An origination fee can be a great differentiator when choosing the best personal loan. You can see the origination fee on the Loan Estimate document offered by your lender. Note that this is not the final rate, and you can negotiate at this stage with your lender. After agreeing to the lender’s terms and conditions, the final origination fee you pay will appear in the Closing Disclosure. You can negotiate for a better overall APR, including a reduction in your origination fee.

Negotiate

You can minimize or avoid paying origination fees on personal loans by simply negotiating your loan application with your lender. If you sense that you are paying more originating fees than the average applicant, either due to a higher loan amount, higher tenure, or better credit score, you can ask your lender to discount the processing fees.

Improve your Credit Score

You can improve your credit score by paying installments in time, having a diverse mix of different credit products, or lowering your credit utilization. You can also use a co-borrower with good credit history to increase your credit score and reduce the processing fee. Note that too many credit checks can ruin your credit score, so only apply for loan applications when you actually need them.

What other fees to watch out for

All lenders do not charge origination fees. Lenders can charge different types of fees along with/instead of origination fees, which are regulated by the Truth in Lending Act. These are-

Application Fee

Some lenders charge borrowers a loan application fee while applying for the loan. Also known as the loan appraisal fee, it goes into document verification and checking your creditworthiness. The lender must provide you with a Loan Estimate document within three days of applying for a personal loan in the US. The Loan Estimate document will contain all the fees, interest rate, APR, monthly payment, and total closing costs of the loan.

Processing Fee

Once you sign the Closing Disclosure, you may need to pay a processing fee to the lender to pay for document verification and loan disbursal. You can pay this fee upfront or pay it from the loan amount.

Administrative Fee

You may need to pay an administrative fee to cover the lender’s operating costs. Loan applications that carry a lot of paperwork and documentation may incur higher administrative expenses.

How does it make sense to pay an origination fee?

The origination fee is not necessarily bad. While some lenders don’t charge any origination fee, it may be merged with the interest rate. Segregating the bank origination fee from the interest rate allows borrowers more freedom to choose the best credit product. The bottom line is in APR, which tracks the overall cost of funds. You can get the best personal loans by browsing the APR of all lenders for your credit score range.

The origination fee is also subjective depending on the type of credit you seek. If you wish to restructure or consolidate your existing debts with a personal loan, paying a one-time origination fee for a lower overall APR may make sense. Also, if you seek a high amount of credit or short-term credit, you can save money by selecting a fixed origination fee model rather than a percentage-based origination fee model. Go through the personal loans guide to know more.

Matthew Levy Matthew Levy Last update:
Matthew is a freelance financial copywriter with 10+ years in financial services. He holds a Bachelor of Science degree in Economics with business and finance options and is a CFA Charterholder. He is from Vancouver, Canada, but writes from all over the world.