A Buyer's Guide to Mortgage Origination Fees

By Brandon Cornett
© 2011 All rights reserved

Reader question: "I'm a little confused by the mortgage origination fees and all of the other charges that get stuffed into a home loan. How does the origination process work and why do we get charged for it? Are these fees negotiable? How much do people pay on average for mortgage origination?"

You've got quite a few questions rolled into one here. So let's address each one in turn. I'm also going to talk about some things you didn't ask but need to know. So let's jump right in...

1. What is a mortgage origination fee?

It's the cost of doing business with a mortgage lender. :-) This is a fee charged by a mortgage broker or lender for originating a home loan. "Origination" is just another word for creation. So the lender is charging you money to create your mortgage loan.

These fees are generally expressed as a percentage of the total loan amount. The bigger the loan, the bigger the fee. They are charged up front as part of your closing costs. The mortgage origination fee makes up the bulk of the lender's up-front profit. Many of the other fees you pay at closing will go toward other people besides the lender. For example, title-related fees will be paid to the title company. The origination fee is how the lender makes money on the front end.

2. How much do these fees typically cost?

On average, homebuyers pay 1% of the loan amount in the form of an origination fee. If you're taking out a loan for $250,000, a 1% origination fee would come to $2500. So the larger the loan, the higher the fee (and vice versa). If your lender is charging you a mortgage origination fee much higher than 1%, you should ask them why. This would be an above-average cost, and would therefore require some investigation on your part.

You should also keep an eye out for something called the mortgage broker fee. This is money paid to the broker who acts as a middleman between borrower and lender. You should only be charged one or the other, but not both. So if you receive a good faith estimate (explained below) that shows both the mortgage origination fee and a mortgage broker fee, you should ask some questions. In most scenarios, you would only pay one or the other but not both.

3. Are mortgage origination fees negotiable?

Yes, origination charges can generally be negotiated downward. But the lender will probably raise the interest rate if they lower their origination fee. So you have to ask yourself two questions:

• Which strategy is going to save me money over the long term?
• What are my priorities regarding upfront costs and long-term costs?

If you're more concerned with minimizing your monthly payments, then you might want to pay additional points up front to get a lower rate. On the contrary, if you would rather reduce your up-front costs, then you should negotiate the origination fee downward and take the higher rate. It comes down to a question of paying the costs now or over the life of the loan. It's really a matter of priority and preference.

But yes, mortgage origination fees can be negotiated during the loan process. If it turns out that your estimated closing costs are too high, you can ask the lender what you can do to reduce them. They may give you the option of taking a slightly higher rate in exchange for lower fees at closing.

4. Can it be financed into the mortgage loan?

Not usually. Lenders charge origination fees in order to (A) cover their up-front costs and (B) make an up-front profit on the loan. They can't do either of these if they roll the fee into the loan. They may agree to reduce the fee in exchange for charging a higher interest rate (see question #3 above), but that's about it. Exceptions might be made for VA loans, as long as the total loan amount doesn't exceed VA limits for the county where you're buying.

5. Is the origination fee tax deductible?

In most cases, you can deduct the amount you pay toward mortgage origination. But you must be buying a home as a primary residence. I'm going to defer to the IRS on this question. Here's a relevant page from Publication 530 of the IRS tax code, which deals with mortgage-related tax deductions.

Scroll down to the section that talks about home mortgage interest and points:
http://www.irs.gov/publications/p530/ar02.html

The flowchart below will help you figure out what fees and points are tax-deductible, and which ones are not. Note: This is the 2011 version of the IRS flowchart. If you are reading this article after 2011, you should visit the link above to see if there's an updated version.

In general, you can deduct the mortgage origination fee if it was used for a home that is your primary residence. Or, as the IRS says: "Your loan is secured by your main home." There are some other stipulations as well, so you really should read this section of the tax code for yourself.

6. When does the lender tell me the cost?

They might tell you what their mortgage origination fees are over the phone or face-to-face. But that doesn't make it official. The first time you'll see it in writing is when you receive your Good Faith Estimate form. Also referred to as the GFE for short, the Good Faith Estimate is a document that mortgage lenders must provide in accordance with federal law.

This form actually got a makeover in 2010. The old version was one-page but highly confusing. The new version is three pages long but much easier to read -- especially for first-time buyers who are unfamiliar with mortgage terminology.

On page 2 of the GFE, the lender will indicate the mortgage origination fee you must pay at closing. They'll also indicate if your fee has been adjusted in some way, perhaps due to the negotiation process we described earlier.

Keep in mind that the Good Faith Estimate does not always reflect your actual closing costs on the day you settle. In the past, the GFE was something of a joke. It was common for borrowers to pay thousands of dollars more on closing day than the lender estimated in advance.

Lenders would downplay costs on the GFE, and then hit the borrower with a bunch of surprises on closing day. It was the "teaser" approach to getting clients, and it was totally unethical.

But there are some new rules in place that reduce this kind of thing. In 2011 and beyond, the mortgage lender must absorb any difference in cost that is greater than 10%. In addition, there are certain estimated costs that are not allowed to increase at closing. On page 3 of your GFE form, you will see a list of charges that cannot increase between the time you receive the GFE and the day you close on the loan. The mortgage origination fee is on this list. This means the lender cannot raise it at closing.