You have heard the term origination fee, read it on a term sheet or settlement statement, and have likely been paid one. However, many are not aware that receiving an origination fee carries potential implications, including limitations on loan terms and usury. If you have not considered the legality of the origination fees that you are collecting, the following will provide a framework for you to do so.
What is an origination fee?
People typically intend one of two meanings when referencing origination fees. The difference between the two uses depends on who receives the origination fee. The more widely accepted understanding is that it is a fee paid by the borrower to a lender. Yet, there are some regions and loan products where the origination fee refers to the fee paid to the broker. For this article, the term will reflect the fee paid to the lender. This definition would consider correspondent lenders where the loan closes in the correspondent’s name, despite being assigned almost immediately. Therefore, the term will not apply where the fee is being paid to a party other than the lender identified in the loan documents.
Additionally, an origination fee should also be differentiated from “lender points,” which typically are paid by a borrower to obtain more favorable loan terms, including lowering the interest rate.
Does State and/or Federal Law Apply?
In general, Federal statutes and regulations concerning lender origination fees only apply to residential mortgage loans under Regulation Z (commonly known as the “Truth in Lending Act” or “TILA”). A residential mortgage loan is a consumer loan secured by a dwelling, which is a residential structure or mobile home containing one to four family housing units or individual units of condominiums or cooperatives. Federal regulation of origination fees is limited to loans where the funds will be used for personal, family, or household purposes that will be secured by a dwelling. Thus, Federal regulations will not apply to business purpose loans or loans secured by property other than a dwelling (i.e., commercial property and 5+ residential property).
In addition to potential regulation under Federal law, the statutes of the states that meet one or both of the following for a transaction could apply: (i) the state in which any real property collateral is located; or (ii) the state identified in the loan documents as the governing law.
Federal Law Considerations
This article focuses on business-purpose loans or loans secured by property other than a dwelling. To that end, there are no Federal law considerations at play. If you are planning to make a loan and charge an origination fee for a loan that does fall under the Federal statute above, note that there are substantial restrictions and regulations relating to origination fees and you should consult with an attorney prior to charging the fee.
State Law Considerations
Unlike Federal law, there are state law implications for consumer and business purpose loans. In this article, we are focusing on business-purpose loans. When making a loan, regardless of applicability of Federal law, lenders should consider the following:
- Which state’s law is the governing law? The only way to ensure compliance is to know what is required to comply.
- Are there any disclosure requirements imposed under applicable state law? Under the statutes of most states, a lender must disclose all fees and costs charged to a borrower, including anticipated lender/origination fees, commissions, yield spread premiums, rebates, and other sources of compensation to be paid, regardless of source.
- Are there limitations on the amount of the origination fee? While there is often a cap on the origination fee for residential mortgage loans under state law, most states do not impose a cap for a business-purpose loan.
- Was the origination fee paid in advance of closing? While in most states, this practice is allowed (especially for business purpose and commercial loans), a couple of states, including California prohibit a lender from collecting an origination fee prior to closing. In California, this practice is permissible if the lender is a licensed California Finance Lender.
- Is a license required to make a loan under applicable state law?
- Under the governing law state’s usury statutes and regulations, is the origination fee included as part of the usury calculation? Only considering the interest rate in the promissory note when performing a usury analysis is a common pitfall for many lenders.
Loan Origination Fees
Although a lender origination fee is collected on a significant majority of loan transactions, many lender recipients have never considered whether the origination fee being collected complies with applicable law. It is critical to remember that regulation of origination fees varies greatly from state to state. They can range from no regulation for business purpose loans to requiring a license and imposing a maximum fee. A lender should not only understand the requirements imposed by the state in which it typically lends but should also consult with an expert that can effectively guide the lender in other states.
If you have questions about whether you can charge an origination fee or if you suspect the fee amount may cause state-level compliance concerns, Geraci is here to help. Our attorneys are experts in nationwide lending and compliance and can assist you to make sure your lending practices are sound wherever you lend.