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Origination Fee: How It Impacts the Effective APR on Your Loan

When you’re applying for financing for your small business, there are dozens of figures and calculations to take into account. One you shouldn’t neglect is the origination fee, because it needs to be included when you are calculating the annual percentage rate (APR) of a loan.

What’s an origination fee?

The origination fee is a fee the lender charges you for handling paperwork and verifying the information on your application—essentially, the cost of employees’ time for dealing with your application.

The origination fee may be expressed as a flat fee (like $500) or a percentage of your loan amount (typically around 3% to 5%). The amount of the origination fee is often rolled into your loan amount, which means you are not only paying the fee, but essentially borrowing the amount of the fee and then repaying it with interest. This is why it’s so important to include the origination fee in figuring out your APR.

What’s the 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 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.

There are many online calculators you can use to figure out the APR of any type of loan or financing product you’re considering (here are Fundera’s APR calculators). Calculating APR is important if you want to compare apples to apples when choosing a loan. Two loans for the same amount and the same interest rate may 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:

  • Loan $10,000 Interest rate 10% Origination fee 2.5% ($250) Term 60 months = 11.1% APR
  • Loan $10,000 Interest rate 10% Origination fee 5% ($500) Term 60 months = 12.24% APR
  • Loan $10,000 Interest rate 10% Origination fee 2.5% ($250) Term 12 months = 14.81% APR
  • Loan $10,000 Interest rate 10% Origination fee 5% ($500) Term 12 months = 19.81% APR

As you can see, the shorter the loan term and the higher the origination fee, the greater the APR.

Why you need to know the origination fee

The origination fee is a key factor in your APR calculations. Not all lenders will tell you the origination fee (at least not upfront) and not all will disclose it in the same way (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, so that you can compare different types of financing—such as business credit card advances, bank loans and merchant cash advances—accurately.  

Rieva Lesonsky

Rieva Lesonsky

Contributor at Fundera
Rieva Lesonsky is a small business contributor for Fundera and CEO of GrowBiz Media, a media company. She has spent 30+ years covering, consulting and speaking to small businesses owners and entrepreneurs.
Rieva Lesonsky