Because lenders use their funds when extending mortgages, they typically charge an origination fee of 0.5% to 1% of the loan value, which is due with mortgage payments.1 This fee increases the overall interest rate paid—also known as the annual percentage rate (APR)—on a mortgage and the total cost of the home. The APR is the mortgage interest rate plus other charges.
For example, a $200,000 loan with a 4% interest rate over 30 years has a 2% origination fee. Thus, the homebuyer origination fee is $4,000. If the homeowner decides to finance the origination fee along with the loan amount, this will effectively increase their interest rate, calculated as the APR.
The monthly mortgage payment, 6% of $200,000, is $954. However, when adding in the origination fee of $4,000 and dividing it out over the 30-year loan, the payments increase by $19 per month for a total monthly payment of $973. The interest is 6%, which incorporates the lender borrowing the funds at 4% interest and extending a mortgage at 6% interest, meaning the lender earns 2% in interest on the loan. This is called the Yield Spread Premium.