When you’re shopping for a personal loan, the first thing you’ll likely want to know is what the interest rate will be. But when you’re figuring out the total cost of a loan, interest rates are just the beginning. They don’t tell you everything you need to know, because interest rates alone don’t take into account any fees you may be charged during the life of your loan. One good example is the origination fee, a one-time fee the loan provider charges for processing the loan. Most lenders charge an origination fee. Some set a dollar amount, but lenders usually structure the fee as a percentage of the loan amount. For example, if you borrow $5,000, you would be charged an additional $50 to $250 on top of the interest rate. Borrowing $10,000 would cost you between $100 and $500 in origination fees. Depending on the loan product that you select, the origination fee may be taken out of the loan proceeds (borrow $10,000 and receive $9,500 in funds) or charged in addition to the proceeds (borrow $10,500 and receive $10,000 in funds). The origination fee isn’t included in the interest rate, which can make it hard to know whether or not you’re paying it. To consider them together, you’ll need to understand your APR. APR is a complicated mathematical formula:
- Your loan amount
- The length of the loan
- Interest rate
- Origination fee
Loan providers are legally required to provide you with both your interest rate and APR as part of any loan agreement.
The origination fee reimburses lenders for performing due diligence, like pulling your credit report and verifying supporting documents. Most personal loan providers charge an origination fee, but they don’t all charge it the same way.
Some require you to pay your origination fee right away by deducting it from your total loan amount. Let’s say you take out a $5,000 loan with a 2% origination fee, making that fee $100. At closing, you would only receive $4,900 because the lender would hold back $100 to pay the origination fee. However, you would be required to repay — and pay interest on — the full $5,000. In this case, it’s easy to see how much you’re paying because you do not receive the full amount of the loan.
Other loan providers add the origination fee to your loan total. Using the same example, if you wanted to borrow $5,000, you would be required to repay $5,100 plus interest, which would result in slightly higher monthly payments than the upfront method.
You may prefer one method or the other, depending on your circumstances. Paying off the origination fee over the life of the unsecured personal loan may be easier to handle given other constraints in your budget. You may not have enough funds on hand to pay the fee upfront, which may be the very reason you are taking out a personal loan in the first place.
On the other hand, you might object to the higher borrowing cost associated with rolling the origination fee into the loan amount, and you may prefer to pay the fee upfront and not owe additional interest.
Take the time to research how your loan provider approaches origination fees. If you need to borrow an exact amount, you may end up coming up short if your loan provider deducts the fee from your loan total. In that case, consider borrowing more to make sure you’re covered.