What is Loan Origination?

Loan Origination Explained

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Origination is a multi-step process everyone goes through as part of the home buying process. Loan origination is a process for obtaining a mortgage or home loan, as well as other types of personal loans. As the name suggests, loan origination is the very first step in home buying. It begins when a borrower applies for a mortgage loan.

What is loan origination?

Loan origination is the term used to describe the process that occurs when a buyer obtains a mortgage loan from a lender. It involves several stages, starting with the borrower’s loan application. Additional steps include submitting appropriate documentation, the lender’s assessment of the application, and the final granting of the loan.

The term “loan origination” is an umbrella term. It includes the entire starting point of the home buying process. It begins when a borrower applies for a new loan, and includes other steps in the process. These processes can include everything the lender has to do to process the application. The loan origination steps end when the lender declines to grant the loan, or approves the loan and disburses the funds.

If the lender approves the loan, the loan origination date is the date when the loan is funded. In other words, the day the borrower receives the money in their account. After loan origination, the loan closing process or settlement takes place, the funds are deposited into the borrower’s account, and the title transfer process begins. The loan origination fee, typically 1% of the loan, often covers this process.

Loan Origination Documents

 

During the loan origination process, borrowers submit a variety of financial information and documentation to the lender. These can include:

  • Tax returns

  • Payment history

  • Credit card information

  • Bank balances

  • Credit report

This type of financial information is what lenders use to determine what type of loan to grant a borrower. A person’s financial information is also used to determine the interest rate the borrower will qualify for.

Loan Origination Example

Jeff and Sue want to buy their first home. They made an offer on a property for $265,000. They start the loan origination process by completing a loan application for a mortgage from their financial institution. They fill in the forms and submit documentation outlining their income, tax returns, and banking details. Their financial institution assesses Jeff and Sue’s financial situation. After inspecting the property, Jeff and Sue are offered a mortgage loan with great terms, thanks to their good credit score.

Mortgage Originators

The mortgage originator is the original lender that approves a mortgage. Mortgage originators are defined as an individual or institution that works with a borrower to process and complete a mortgage transaction. A mortgage originator might be a mortgage banker (or the bank that person works for) or a mortgage broker. This can depend on the type of loan the borrower chose to pursue. 

Mortgage loan originators manage the loan origination process through all its steps, from application to funding a mortgage loan. A loan originator can either be independent or work for a lender. The distinction is important—originators who work for lenders prioritize the bank’s interests. On the other hand, an independent loan originator can help buyers select the best type of loan. An independent loan originator may even know lenders who offer the best terms.

When it comes to home loans, mortgage origination is more complex than other types of loan origination. There are more requirements, which means more paperwork. There are many loan products available, and each one has different eligibility requirements. Therefore, it can take quite a bit of work to pair a buyer with the best mortgage loan. On top of all that, there are many consumer protection regulations that can affect the length of the process.

Loan Origination Fees

To cover the costs of processing the borrower’s application for a new loan, most lenders require upfront compensation. This is similar to a commission for processing the loan. This sum of money is called the origination fee. Lenders typically charge somewhere in the range of  0.5% to 1% of the total loan amount as the origination fee. 

The math works like this: a 1% origination fee for a home loan of $100,000 equals $1,000. A 1% origination fee would be $2,000 for a $200,000 loan. In many cases, the loan origination fee can be negotiated. However, loan origination fees are most often reduced for larger loan amounts, like jumbo loans.

The origination fee is charged by the lender to process a new loan application. Origination fees are used as compensation for putting the loan in place. These services and fees usually include:

  • Application fee: lender’s cost to process your loan application.

  • Commitment fee: this guarantees a loan at a later date even though the credit is not being used at the time.

  • Document preparation: a document prepared by the lender for getting you a loan.

  • Funding fee: money used to transfer your loan money.

  • Origination or lender fees: money charged by the lender for preparing your loan.

  • Processing: money charged by the lender for processing your loan.

  • Tax service: money collected by your lender and placed in your escrow account. Then, it is put toward your property taxes.

  • Administrative Fee: usually covers document preparation.

  • Underwriting fee: charged for taking a risk with your home loan.

Buyers with large loans can often negotiate lower origination fees because lenders can make concessions to earn their business. A $50,000 loan usually requires the same amount of work from the lender as a $500,000 loan. This is why the origination fee can represent a higher percentage of the loan amount on smaller loan amounts.

The Lender's Part in the Loan Origination Process

Let’s take a look at the loan origination process from the lender perspective. In this section, you’ll learn where the costs to originate a loan come from.

Marketing

The lender advertises its products through radio, print, digital, and other ways. By marketing loan products, lenders can interest potential borrowers in working with them when they need a loan.

Point of Sale

A borrower contacts the lender to request a loan application. The loan officer collects the borrower’s financial documents and orders a credit check. The loan officer uses this information to determine whether the borrower is qualified. The loan officer and borrower work together to agree on loan options and terms. The interest rate is locked in, and the loan paperwork is forwarded to the processing department.

Processing

The processor verifies the financial records to determine the borrower’s creditworthiness. The processor then completes a variety of documents including 4506-T forms. Form 4506-T is used by taxpayers to request copies of their tax return information. Taxpayers can also designate a third party, such as a lender, to receive this information. The processor then orders a variety of services including appraisals, flood and title reports, insurance, and so forth. Then the loan is submitted to the underwriting department.

Underwriting

The underwriting department reviews all the documentation collected in the previous steps. They determine whether the underwriting guidelines and conditions for funding are met. A second credit report is typically ordered, and the final decision to fund the loan takes place. Once all the requirements for underwriting have been met and completed, the underwriter notifies the closing department.

Closing and Funding

After the underwriting department forwards the loan package, it’s then reviewed by the closing department. The closing department confirms fees and special requirements. They also send closing instructions to the settlement agent to prepare and execute the closing documents. The buyer(s) sign the documents at closing. The signed documents are reviewed, the funds are disbursed, and the loan moves to the quality control department.

Post-Closing

The lender’s quality control department reviews the loan. They register it with a central clearing house that facilitates future transfers between investors. The quality control department sets up the loan for servicing prior to potential transfer of the servicing rights to a third party.

Finally, the loan package is shipped out to the borrower. Lending institutions are required to record each loan application and submit compiled data to regulators. Failure to submit on time or submitting incorrect data can cost the lender massive regulatory fines.  

Lenders definitely don’t want to violate regulations—the costs of loan origination are too high. These financial institutions don’t want to be fined. Nor do they want to disqualify themselves from being able to sell the loan on the secondary market. So, it pays to detect regulatory exceptions before funding the loan.

Borrower Steps in the Loan Origination Process

 

The loan origination process from the borrower perspective has many steps, including:

  • Loan application — The homebuyer (borrower) fills out a loan application form.

  • Documents — Either during the initial application or after pre-approval, the buyer submits documentation to verify income, employment, and financial status.

  • Screening — The lender screens the loan application. This verifies the buyer’s credit score. It also determines if the buyer’s income and financial status qualify the buyer for the loan.

  • Negotiation — This stage doesn’t always happen, but sometimes there are opportunities to negotiate more favorable loan terms.

  • Finalize loan application —Both parties agree on the terms. Then, the loan application is processed by the lender following the steps in the previous section of this page.

  • Loan approval — After final processing, the lender decides to approve or reject the loan application.

Let’s take a look at some of these processes in greater detail.

Pre-Qualification

 

Pre-qualification is the first step of the mortgage process. The loan officer meets with the borrower to begin collecting information relating to income as well as the real estate property that the loan will cover. This is when the lender determines what kind of loan the borrower qualifies for. Usually, it’s one of three common loan types:

  • Fixed-rate home loans have a continuous interest rate for the entire life of the loan.

  • Adjustable-rate mortgages (ARMs) have an interest rate that fluctuates in relation to an index, similar to Treasury securities.

  • Hybrid loans feature interest-rate aspects of both fixed and adjustable loans. They most often begin with a fixed rate and eventually convert to an ARM.

Some borrowers are eligible for a government loan. Two examples of government mortgage loans are those provided by the Federal Housing Authority (FHA) or the Department of Veteran Affairs (VA). These loans are considered non-conventional and make it easier for people to qualify to purchase homes. These loans often feature lower qualifying ratios and may allow for a smaller or non-existent down payment.

During pre-qualification, the borrower gets everything together on their list of information needed to complete loan applications. The extensive required documentation includes a variety of items, as we’ve discussed elsewhere on this page. The pre-qualification documents may also include mortgage statements if the loan is a refinance of an existing mortgage. The lender may also request additional documentation.

Loan Application

During this phase of the process, the borrower completes a loan application loan and submits all the necessary documentation. The loan officer discusses which loan options are available to the borrower. The loan officer and the borrower work together to choose the one that works best for the buyer’s situation. 

Loan Filing

At this point, the process is out of the borrower’s hands. All the paperwork up to this point is submitted, signed, and filed. It’s then processed by an automatic underwriting program to be approved. During this process, files may be sent to an underwriter for manual approval. After approval, the loan officer schedules a closing, gets the appraisal, requests insurance information, and sends the loan file to the processor. As a follow-up, the processor may request additional information, if necessary, for reviewing the loan approval.
 


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