All loans have 3 components: loan origination, loan servicing, and investing in the loan. Sometimes the lender wears all 3 hats; originating, servicing and funding the loan. That’s not always the case, as many mortgage borrowers have learned when their servicing is sold to another firm.
It’s not a charity, it’s a business
Loan origination isn’t free, even when there are no upfront fees. When you take out a personal loan you’re paying the expense involved with loan origination. The loan originator isn’t doing it for charity.
With some personal loans, the expense is baked into the interest rate and there are no upfront costs. For others, the borrower is expected to pay the expense at closing. Knowing which approach your lender uses can influence several important decisions about your loan.
Better credit means lower fees
If you’re paying the loan origination fees upfront, then you may need to borrow more money to cover that cost. If you’re trying to consolidate $10,000 in credit card debt, and the origination costs are $500, you may want to borrow $10,500.
Origination fees can vary by borrower. Higher credit scores and higher income levels should mean lower origination fees and definitely lower interest rates.
Does it matter how you pay?
Should borrowers care whether they pay the origination fee upfront, or it’s paid over time in the interest rate? In comparing quotes on personal loans, the borrower should compare the annual percentage rates (APRs) on the loans.
The APR calculations aren’t perfect but the intent is to let borrowers compare loan offers among lenders on an apples-to-apples basis.
No prepayment penalties can change things
One possible advantage of having the origination fee priced into the interest rate is if you plan to pay off the loan early, and actually do it.
The typical personal loan doesn’t have a prepayment penalty, so paying the loan off early reduces the expense.
While paying the origination fee upfront should make for a lower stated interest rate on the loan (not APR), you either have to come to closing with cash or borrow an additional amount to cover the fee.
Would you rather pay an upfront origination fee or have it priced into the interest rate on the loan?
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