As you shop for mortgages, you will most likely bump up against the mortgage origination fee. You may be wondering what exactly it covers, why some lenders charge it and others don't and why any home buyer would choose a mortgage with an origination fee when there are no-fee options out there. Confusing, right? Let’s take a look.
Mortgage Charges Explained
First, a little background. All lenders charge fees that can be thought of in two broad categories:
Fees For Services
These charges, which may include underwriting, processing, appraisal, credit report, flood certification and tax service, are often grouped under a larger umbrella known as an administrative fee.
Fees For the Lender’s Profit
This charge, most commonly referred to as a mortgage origination fee, may also be called “points,” “discount points” or, more recently, “the cost or credit for the interest rate chosen.”
How a Lender Makes Its Profit
You might think that the lender earns its money from the interest you pay over time, but in almost all cases this isn’t how it works. Lenders (even banks and credit unions) make loans and then sell almost all of them to Fannie Mae, Freddie Mac or institutional investors, such as insurance companies or Wall Street hedge funds. Lenders don't work for free, so how do they get paid? Let's use an example.
A lender offers you a $200,000 loan at a 4.5 percent interest rate and charges you a $6,000 (3 points) mortgage origination fee. An investor comes along who wants to earn 4.5 percent. Your payments exactly match the investor’s required yield for the investment, so the investor buys your loan for $200,000. In this scenario, the lender makes its profit by charging you a fee.
A lender offers you a $200,000 loan at a 4.75 percent interest rate and charges you no fee (zero points). An investor would typically pay a premium for this loan — we’ll use $206,000 as an example — because that still gives the entity a yield of 4.5 percent. In this scenario, the lender makes its profit when it sells your loan to the investor.
So you see the lender makes its money either way. You are simply choosing between paying more money now, or more money every month for as long as you keep the loan.
Should I Pay a Mortgage Origination Fee or Choose a Higher Interest Rate?
The answer to this question depends on your circumstances, concerns and goals. If you have very little cash when you buy your new home, you’re probably better off taking a no-point loan and making higher monthly payments so you can conserve your limited cash. If you think you’ll only keep the loan for a couple of years, you are probably better off with a zero-point loan because the higher payments will not cost as much as the upfront fees.
On the other hand, if you have the cash and expect to be in your home for a long time, you might save quite a bit of money by paying a loan origination fee. In the long run, you could pay far less between upfront and interest costs. Your mortgage adviser should be able to do the math for you and compare your total cost of two different loan options, depending on how long you intend to stay in your home.
Would a Broker Charge a Mortgage Origination Fee?
Brokers are almost always paid directly by the lender out of its profit. This is the money the lender would have paid its own staff to originate and package your loan; the lender just hires brokers in addition to its own staff to expand its marketing efforts. A loan origination fee almost never goes directly to the broker.