Understanding loan fees and charges

Key takeaways:

• Loan fees can impact your total cost more than you think. Always read the fine print.
• Some fees are negotiable, so don’t hesitate to ask for better terms.
• Use APR to compare loans and get a clearer view of the overall cost.

When you’re exploring loan options, you may have to look beyond the numbers at the top of your phone or computer screen to get the whole picture. Fees and charges are often tucked away in the fine print, and you’ll have to do a little reading to figure out the true potential cost of some loans. Understanding loan fees and charges is essential for your finances when shopping for a new loan.

If you’re wondering what is an origination fee on a loan, or want to know more about less common charges, like a prepayment penalty or returned payment fees, you’ve come to the right place. Here’s a closer look at what every savvy borrower should know about loan fees and charges.

Types of loans and their associated fees

As you navigate your personal finances, you’re likely to come across several types of loans. These are some of the fees you may encounter with several popular types of installment loans.

Personal loans

A personal loan is typically an unsecured loan, where you borrow a specific amount and repay it in equal monthly installments over the loan term. Your credit history, income, and other factors typically play a significant role in determining whether you are approved and what your interest rate will be.

Many lenders charge an origination fee, which is a fee for creating a new loan. They may also charge a documentation fee for handling the new loan paperwork. Most other fees can be easily avoided if you repay the loan as agreed. For example, late payment and returned payment fees can add up quickly if you miss a due date or don’t have enough cash in the bank to cover a monthly payment. But if you pay on time every month, you may only have to pay an origination fee and interest.

Mortgage loans

Mortgage loans are used when buying a home, and typically come with a much longer list of charges. In addition to the standard origination fee, you may also be required to pay an application fee and a credit report fee, for example. You’ll also likely have to pay third-party costs, such as an appraisal and title insurance charge.

Home loans are often the biggest loan you’ll ever get, and can easily reach into the six-figure range. If you’re paying any fees as a percentage of the loan amount, pay close attention.

Auto loans

While some buyers save up and pay cash for a vehicle, the National Automobile Dealers Association reports that more than 80% of buyers finance their purchase with a loan. The fees can vary widely based on the lender and vehicle. You can shop around for the best loan rates and don’t have to go with the dealer’s offer.

If you’re hunting for a loan for a vehicle purchase, you can find all fees listed on the Truth-in-Lending Disclosure, which includes your interest rate, fees, total loan amount, and monthly payment amount. Be on the lookout for origination fees, prepayment penalties, and other dealer or lender-imposed charges. Also, remember that many of these fees may be negotiable.

The most common loan fees

When borrowing money, your biggest cost is usually interest, which is how much you pay each month to borrow the funds. Knowing how interest works and what other fees you can expect helps you understand the total cost and compare different loans.

Insight on interest rates

Interest rates are determined by a mix of factors, including the type of loan, your creditworthiness, and market interest rates. Of those factors, the one you have the most control over is your credit score. Try always to make loan payments on time and keep your credit card balances low to build a good to excellent credit score.

Loans with collateral, such as home loans or auto loans, typically have lower interest rates than unsecured personal loans. That’s because the lender has some protection if you stop paying as agreed. While we hope it never happens, a lender can foreclose on a home or repossess a car, for example. But that’s not the case with unsecured loans, so you can expect higher interest rates for personal loans.

Common fees: origination fees and prepayment penalties

Aside from interest, one of the most common borrowing costs is an origination fee. Those can be a flat fee or a percentage of the total loan amount. You should know how much you’ll pay in origination fees before signing any loan documents. Some lenders don’t charge origination fees, and some offer lower origination fees for borrowers with the best credit scores.

A prepayment penalty is a fee for paying off your loan early. It’s best to find loans without prepayment charges, so you don’t have to pay extra if you’re able to pay off the loan before the due date. Whenever you’re borrowing money, it’s essential to read the contracts and decipher any complicated loan terminology so you don’t encounter unexpected expenses in the future.

Interest rates: Fixed vs. variable

When looking at loan options, you’ll probably notice that interest rates come in multiple flavors. Fixed and variable interest rates work differently, and it’s important to understand which one makes the most sense for your financial goals.

Understanding fixed interest

Fixed interest means your interest rate is locked in for the entire loan term. For personal loans, the term is typically one to five years. For auto loans, you’ll commonly see terms as long as seven years. And for mortgage loans, you can lock in your rate for a full 30-year term.

Fixed rates are best when interest rates are low and you plan to keep the loan for a long time. In any case, they offer a predictable monthly payment that won’t change for the entire life of the loan.

Exploring variable interest

A variable interest rate means the loan’s cost can fluctuate with market rates. In many cases, you’ll have a fixed rate for a specific period, and the rate will adjust periodically thereafter. If you think interest rates will decrease, a variable rate may be a better option. On the other hand, if rates rise, you’ll have to pay more interest, and your payments may increase.

Variable interest rates are sometimes lower than fixed rates, so if you plan on paying off your loan early, they may be more attractive. But consider the pros and cons, and if you can afford a higher payment, before accepting a variable-rate loan.

Comparing APRs

When deciding on a variable rate or a fixed rate, there is no perfect answer for everyone. It’s all about your financial situation and goals. But once you’ve decided between the two, you have a powerful tool to compare the all-in cost of a loan: the annual percentage rate (APR).

APR helps you compare different loan options on an apples-to-apples basis, including interest and fees. APR explains how much you’ll pay per dollar borrowed per year. In almost all cases, a lower APR is better.

Strategies to minimize loan costs

Just about every borrower wants to find a loan with the lowest costs. If you’re looking to minimize interest and fees, it’s wise to compare different loan options and negotiate when possible.

Comparing lenders and fees

As we discussed above, the best way to compare two loans is by using APR. Because APR includes interest and other fees, it helps you quickly understand what you would pay for a loan and which is the lowest-cost option when comparing multiple offers.

Shopping around with multiple lenders and comparing different loan terms can help you find the most affordable option. You may find a high rate from one lender and a low rate personal loan from another.

Some lenders can give you an interest rate and fees with only a soft credit check, which doesn’t impact your credit score.

Importance of negotiation

While not all lenders are willing to negotiate fees, many are happy to have that discussion if it leads to winning your business over a competitor. Negotiating can feel awkward, but it’s worth the extra effort if it can save you hundreds or even thousands of dollars.

For example, you might be able to negotiate with a lender to lower or eliminate your origination fee. If you can, that’s a big win for your bank account.

FAQ about loan fees and charges

What does it mean when a loan advertises ‘no closing costs’?

Closing costs often refer to origination fees, but can include other charges as well. Some lenders try to make that up with higher interest rates, so look at the APR to understand what you’ll pay over time.

What loan fees are considered ‘hidden costs’?

Regulations require most lenders to clearly disclose any fees and costs upfront. However, you may not notice certain fees that may arise in specific situations, such as late payment fees, prepayment penalties, and nonsufficient funds charges.

How are loan fees calculated?

Every lender has the freedom to decide on fees and other loan charges. Your credit history, loan size, and loan type are among the most common factors used to calculate loan fees.

Do online lenders offer lower loan fees?

Online lenders don’t have to pay for expensive bank branches, and they’re often willing to pass on those savings as lower loan costs for customers. Comparing multiple online lenders with traditional banks and credit unions can help guide you to the most affordable loan.

How is a prepayment penalty calculated?

Prepayment penalties can be calculated using one of several methods, and the fees you may have to pay should be clearly explained in your loan agreement. Lenders may charge a fixed fee, a certain number of months of interest, a percentage of the remaining balance, or a percentage of the original loan amount for an early payoff.

The bottom line: Borrowers need to review all loan fees

Reading fine print and documents to find loan fees and charges might not feel exciting, but it’s a smart move for your financial future. When you understand what fees to expect, which ones are negotiable, and how they impact your overall borrowing cost, you’re positioning yourself to pick the best possible loan for your needs.