Origination fees taken out of proceeds versus added to the balance

The two structures

A fee deducted from proceeds means you borrow $100,000, receive less, and repay a schedule built on $100,000. A fee added to the balance means you receive $100,000, and repay a schedule built on a larger principal.

Lenders describe both as "a 4% origination fee". They are different transactions with different payments, different totals, different cash and different effective rates, and the one that is better for you depends on which of those four things you are short of.

Worked, on identical inputs

Illustrative only — $100,000, twelve monthly payments, a 15% nominal note rate, and a 4% origination fee.

Note what happens to the ranking. B costs $332.36 more in total dollars and $4,332.36 more in payments, yet B carries the lower effective rate — because B also handed you $4,000 more cash. Comparing totals without comparing proceeds gets this backwards every time.

The grossing-up error

If you need $100,000 in the bank and the fee is deducted, you do not borrow $104,000. Borrow $104,000 with 4% deducted and you receive $99,840.

The right figure is $100,000 / 0.96 = $104,166.67. The fee is $4,166.67, the payment becomes $9,401.91 and the total is $112,822.92.

The same trap sits inside the fee percentage itself. A 4% fee deducted from $100,000 is $4,000 charged against the $96,000 you kept, which is 4.1667% of your money. Small here. On a ten-point fee it is the difference between 10% and 11.1%, and on a deal where points are deducted and a factor is applied to the gross, it compounds with everything else in the same direction.

Which structure to prefer

What prepaying does to the fee

Both structures get worse if you repay early, because the same fee is spread over fewer payments. Illustrative only, on the same figures as above — repaying after six of the twelve payments:

B separates a little further from A when you prepay, because interest stops running on the part of the fee you have not yet amortised, while a deducted fee is simply gone. But the gap between the structures is a third of a point, and the effect of prepaying is nearly three points. If you expect to refinance or sell inside the term, the argument to have is not about which structure the fee sits in; it is about how large the fee is at all.

The fee you pay twice

Two places it happens, both routine and neither flagged in advance. On a renewal, a fresh origination fee is usually charged on the whole new balance, including the part that is a rolled-over payoff of the old loan — points on money you already paid points on. On a modification — a payment holiday, a re-amortisation, a change of collateral — most agreements permit a fee for processing it, and the day you need one is the day you have least standing to argue about it.

Ask for the fee in dollars at every one of those moments, not as a percentage. A percentage sounds like a rate. The dollars are the price.

Two smaller traps

The check to run on any offer

1. Write down the cash you will actually receive.
2. Write down every payment and its date.
3. Solve for the rate on those two things, not on the note amount.
4. Repeat for the other offer, on the same basis.

Two offers quoting the same fee percentage will not usually survive that comparison in the order the term sheets suggested. The calculators take the fee and the deduction method as separate inputs for exactly this reason.

One more thing worth asking in writing: whether the fee is earned at commitment or at funding. A fee earned at commitment survives your decision not to proceed.