When you decide to participate in a real-estate project, you will be faced with all sorts of figures and calculations. One important number to be aware of the is the origination fee on your loan, because it affects the calculation of your annual percentage rate (APR) and the amount of interest you ultimately will have to pay.
An origination feeis charged by lenders for verifying your loan application and generally taking care of all the paperwork associated with a loan. It takes time and money for the lender’s employees to track down and maintain all the necessary information, and the origination fee compensates the lender for these costs. You might see the origination fee expressed as a flat amount or as a percentage of the loan amount. Typical origination fees can reach the 3 to 5 percent range. In many cases, the lender will roll the origination fee into the loan principle, meaning you don’t have to pay it separately, but will be paying interest on the fee. You can choose to pay it up front if you like, to avoid paying additional interest on it.
The APRof a loan is usually higher than the loan’s interest rate, because the APR includes any fees, such as the origination fee. The APR calculation includes inputs for the loan amount, the interest rate, the loan term and fees. But don’t worry about the calculation. First of all, there are numerous online calculators available that will compute the APR for you. Secondly, your lending agreement will explicitly state the loan’s APR, as a matter of law. The importance of APR is that it puts competing loans on an equal footing, so that you can compare them with each other. Two loans sharing the same principle amount and interest rate can have widely different APRs, depending upon the loan’s fees and term.
Let’s assume you take out a $100,000 real estate loan with a 10 percent interest rate. The APR will vary depending upon origination and other fees, as well as the loan term. If the origination fee is 2.5 percent or $2,500, a 12-month loan will have an APR of 12.492 percent. The same loan with a 5 percent origination fee will have an APR of 14.930 percent. The same loans made for a six-month period would have APRs of 13,293 percent and 16.506 percent, respectively. As you can see, all things being equal, a shorter loan term can translate into a higher APR.
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