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What Is a Personal Loan Origination Fee?

| Money Rates Columnist
min read

people-getting-a-loanWhat's a personal loan origination fee? Is it always required? And if not, why would you ever want to pay it?

The answer, of course, involves money and who gets it. If you look only at personal loan interest rates, you may miss the financing's real cost. Without considering the lender's fees, you can't tell which loan is a bargain and which one is wildly more expensive. To get a better understanding of the loan's cost, you need to look at the annual percentage rate or APR.

See personal loan interest rates

What Is a Personal Loan Origination Fee?

Many personal loans - but not all - charge interest plus an upfront charge called an "origination fee." An origination fee is income to the lender and may be characterized as the cost of setting up the loan. But it doesn't really matter what lenders call loan costs. They can call them "hamburgers" and the result is the same - you paying money for the privilege of borrowing. The main takeaway here is to consider the total cost of financing when you compare personal loan offers.

Origination fees add to the cost of the loan. Is it better to have a lower rate and higher fees? Or pay a higher rate with lower fees? That depends on the combination, and that is why lenders must disclose the APR when they advertise an interest rate. The APR incorporates both the fees and interest, and makes it easier to compare personal loans with different rates and fees.

Here are some examples with a $4,000 loan at 10% and a four-year term. The cost can vary wildly depending on how the interest is calculated and the amount of the fees.

No-fee loans

Many borrowers look only at the interest rate when shopping for a personal loan. If the lender charges no fees, the APR and advertised or "stated" interest rate should be identical.

  • In this example the 10 percent interest rate is also a 10-percent annual percentage rate (APR).
  • The monthly payment is $101.45.
  • The loan's total interest expense is $869.62.

Loans with origination fees

In this case we have the same loan but the lender has an up-front origination fee equal to 5% of the loan amount, or $200.

  • If we pay the $200 in cash up-front, the APR is 12.738%.
  • The monthly payment is $101.45.
  • The loan's total interest expense is $869.62 plus $200 upfront or a total of $1,069.62.

Financing your origination fee

Maybe $200 at closing is not something we want to pay. Instead, we add it to the loan amount. Now the total debt is $4,200. The cost of borrowing increased, but we got to borrow $4,000 for our $200 fee instead of just $3,800. So the APR is slightly lower.

  • The APR is 12.603% plus we avoided a big upfront cost.
  • The monthly payment is $106.52.
  • An extra $6.52 cents over 48 months (four years) adds $312.96 to the loan's cost.
  • The loan's interest expense is $1,113.10 plus the loan size was increased to $4,200. Between the interest expense ($1,113.10) and the extra principal ($200), the total cost to finance this loan is $1,313.

The role of a shorter term

Instead of four years to repay $4,000 let's say we elect to pay off the debt in three years. The lender still wants a $200 fee, and this time, we pay it upfront.

  • Now the APR is 13.562%
  • The monthly payment is $129.07.
  • The total interest cost is $646.47.

If the fees remain the same but the loan term shortens, the APR increases. That's because you're spreading out the loan costs over less time. Notice that although the APR is higher, with a shorter term and bigger monthly payments, the actual interest cost for the loan is lower.

The chart below summarized the loan scenarios we have just demonstrated.

Loan AmountInterest RateTerm (Years)Origination FeeAPRMonthly PaymentTotal Cost
$4,00010%4$010.000%$101.45$869.62
$4,00010%4$20012.738%$101.45$1,069.62
$4,20010%4$20012.603%$106.52$1,313.10
$4,00010%3$20013.562%$129.07$646.47

APR Problems

And that is why you can only use APR to compare loans when:

  • The repayment term is the same
  • The loan fees will be treated the same way (paid upfront or financed)

When comparing loans with different terms and methods for covering loan costs, the total cost of financing is a more accurate way to compare loans.

How Much Is a Personal Loan Origination Fee?

Upfront origination fees vary depending on your credit status and the lender you select. Most mainstream personal loan providers charge upfront origination fees ranging from 0% to 6% of the loan amount. Some charge a flat fee instead. Flat fees are better for larger loans than smaller loans.

If you borrow $1,000 and the origination fee is 6%, that's $60. That's .06 * $1,000. If you borrow $10,000 and the origination charge is 3%, your charge is $300. That's $10,000 * .03. The average personal loan origination fee is about 3%.

Are There Personal Loans With No Fees?

Yes. To find such loans you need to shop around. Also, beware that a loan without an "origination fee" may have a higher rate. You have to look at all fees and charges - regardless of what they're called - to fully understand the loan's cost. The table below shows three loans. One has a 10% rate and no fees, one has a 9% rate and a 1% origination charge, and one has a 7% rate and A 6% charge.

Loan AmountInterest RateTerm (Years)Origination FeeAPRMonthly PaymentTotal Cost
$4,00010%4$010.000%$101.45$869.62
$4,0009%4$409.528%$99.54$817.93
$4,0007%4$24010.233%$95.78$837.68

In this case, the loan with the second-highest interest rate has the lowest APR and costs. The loan with the highest rate and lowest fees actually costs most over the term of the loan.

Why Would You Consider a Personal Loan With an Origination Fee?

If you are looking at two personal loans with the same interest rate, and one has fees and the other doesn't, of course you'd pick the loan with no fees. But as we've demonstrated above, the loan with an origination fee can actually cost you less over its entire term. That's why it's important to look at your personal loan disclosures and compare APR and financing costs.

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