Business Loan Origination Fee: How It Impacts Your Total Loan Cost

When you’re applying for a small business loan, there are dozens of factors to take into consideration. One of the most important things is how much you’ll pay for the loan.

Total loan cost is impacted by your interest rate, as well as fees. Many lenders charge origination fees to compensate themselves for the cost of evaluating and processing your loan application. Here, we’ll explain more about how origination fees work, how much they usually are, and how they affect your borrowing cost.

How Origination Fees Work

The origination fee is a fee the lender charges you for handling paperwork and verifying the information on your application—essentially, the cost of the lender’s time for processing your application. For instance, the lender needs to check the borrower’s credit score, review tax returns, and verify the borrower’s income. The origination fee offsets the time that the lender takes to evaluate a loan application.

Some lenders charge a flat origination fee (like $500). However, more commonly, lenders charge an origination fee as a percentage of your total loan amount (typically around 3% to 5%). For example, if you take out a $100,000 loan with a 5% origination fee, the fee is $5,000. Often, the lender will just “skim” this off from the total loan balance. In the example, the lender would take the $5,000 fee and send the $95,000 balance to your bank account, but you still have to pay back $100,000 plus interest to the lender.

Sometimes, the origination fee might vary based on how much money you’re borrowing and on whether you are a first time borrower. OnDeck, for instance, charges borrowers an origination fee of 2.5% to 4% for their first loan. The origination fee for second-time borrowers is lower, and if you pay your loans back on time, you could pay no origination fees as a third-time or successive borrower.

How Much Are Origination Fees?

The size of the origination fee depends on the type of business loan you’re applying for, as well as the specific lender that you’re working with. Some lenders might charge a lower origination fee, but a higher interest rate.

Here are approximate origination fees on business loans:

• Short-Term Loans (terms of two years or less) – 1.5% to 9%
• Medium-Term Loans (two to five year terms) – 3% to 6%
• Conventional Bank Loans – o.5% to 1%

As you can see, short-term loans generally come with higher origination fees. Short-term loans typically are unsecured business loans, which means that they aren’t backed by collateral. Borrowers who receive short-term loans also tend to have lower credit scores. And since the terms are under a couple years, lenders don’t receive much money in the way of interest. For these reasons, short-term lenders charge higher origination fees to offset some of their risk and recoup their lending costs.

Bank loans tend to be secured business loans and go to creditworthy borrowers who pay a significant amount of interest over the life of the loan. For those reasons, banks charge lower origination fees. That said, even within a loan category, there can be big variations depending on which lender you’re working with.

If you’re on the market for an SBA loan, you should know that SBA lenders can’t charge origination fees. However, they can charge reasonable packaging fees. Plus, the SBA itself charges a guarantee fee ranging from 2% to 3.75% of the guaranteed portion of the loan.

Before you sign your loan agreement, check the fees section for full disclosure of any origination fee and how it works.

How Do Origination Fees Affect Your APR?

The annual percentage rate (APR) is different from the interest rate you’re charged on a business loan—and is generally higher. The APR tells you the total borrowing cost of your loan on an annual basis. APR takes into account the interest rate, the amount of the loan, the loan term (how long it’s for), and any fees, including origination fees. Any fees that a lender charges end up increasing your borrowing cost. This is why it’s so important to include the origination fee in calculating your APR.

Fundera’s business loan calculators can help you figure out the APR of your loan. Calculating APR is important if you want to compare loan products apples to apples. Two loans for the same amount and with the same interest rate might have very different APRs when you factor in terms and fees.

For example, suppose you apply for a loan of $10,000 with a 10% interest rate. Depending on the terms of the loan and the amount of the origination fee, the APR can vary quite widely. Here’s an example of how it works out:

• $10,000 loan, 10% interest rate, 2.5% origination fee, and 60-month term = 11.1% APR
• $10,000 loan, 10% interest rate, 5% origination fee, and 60-month term = 12.24% APR
• $10,000 loan, 10% interest rate, 2.5% origination fee, and 12-month term = 14.81% APR
• $10,000 loan, 10% interest rate, 5% origination fee, and 12-month term = 19.81% APR

As you can see, the shorter the loan term and the higher the origination fee, the greater the APR. This doesn’t necessarily mean that you have to completely write off high-APR loans. These loans are suitable when you need to borrow money for a short time frame—to buy inventory or make payroll, for example. And your total repayment amount ends up being less when you hold onto a loan for a shorter time period. That said, you should know how origination fee affects your APR.

Origination Fee: Tips for Business Borrowers

When you’re shopping for a business loan, you’re bound to come across some products which carry origination fees. Here are some tips to minimize the impact of origination fees:

• Negotiate with the lender – You might be able to negotiate a lower origination fee, especially if you’re borrowing a large amount of money. Similarly, if you’re a creditworthy borrower or willing to put up collateral, you might be able to use those factors to bring down the fee.
• Leverage your borrowing history – If you’ve worked with the same lender in the past and have a positive repayment history with them, they might be willing to reduce or eliminate your origination fee.
• Deduct the origination fee on your taxes – The good news is that most loan fees, including origination fees, are a tax deductible business expense. That means you can subtract the amount of the fee from your taxable income, which lowers your overall tax burden.

Origination fees are something to watch out for, but they don’t necessarily have to be a deal breaker, especially if you follow the tips above.

Bottom Line on Origination Fees

The origination fee is a key factor in determining your total borrowing cost. Not all lenders will tell you the origination fee (at least not upfront), and not all will disclose it in the same way. For example, it may be a percentage or a flat fee. Before committing to anything or signing any documents, you need to make sure you understand the origination fee (along with any other fees and extra costs associated with the loan) and include it in your calculations.

Knowing the APR of a loan or other financing product enables you to figure out the true cost of that financing over a year. As a result, you can compare different types of financing accurately and choose the product that’s the best fit for your small business.

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