The loan origination process is an essential step that occurs in the background when individuals seek capital from lenders.
This involves creating and issuing a loan with an originator, the lender, or the financial institution providing funds. While this process may seem simple in the eyes of the applicant, the lender is doing a thorough and lengthy review to make a lending decision.
This article will cover everything about this process: its meaning, benefits, and stages to ensure you understand what happens when you apply with a lender.
What Is Loan Origination?
Loan origination is a process lenders use to assess and approve a loan application. It starts when individuals apply to obtain capital, such as a business loan, a home loan, or a mortgage.
When a borrower submits an application and files the necessary financial documents, the lender will verify the applicant's creditworthiness and financial capacity and ensure the loan structure is appropriate for both the applicant and the lender.
After they review everything, they determine whether they will accept or reject the borrower's application.
Once the lender establishes that the applicant met all eligibility criteria, they can finalize the loan documentation, and funding can take place.
The Federal Deposit Insurance Corporation, or FDIC, oversees the process and applies certain amortized personal loans to originate a loan.
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Different financial institutions as traditional banks, online lenders, credit unions, and others, include the loan origination process within their application and approval process.
What Are The Benefits Of Loan Origination?
- It helps identify and reduce the risk for lenders assessing a borrower's creditworthiness. For applicants, it allows them to receive approval only for loans they can afford and won't hurt their finances.
- Loan origination can streamline the lending process and offers transparency for all parties involved, ensuring compliance with FDIC rules and regulations.
- Origination can help lenders reduce the paperwork necessary to approve or deny a loan. This makes applying for a loan more straightforward.
- Automizing the loan origination process can optimize the lending process, improve overall efficiency, and boost customer experience. This allows the application process to be faster and smoother.
Loan Origination: Common Loan Requirements
There are a few requirements you must meet before you can start the loan process.
During the pre-qualification process, a borrower provides essential information about themselves, the purpose of the loan, and their finances.
There are specific documents you need to provide when applying for a loan. These documents typically include the following:
- Proof of your income, such as tax returns, W-2s, and 1099s
- Proof of your current assets and expenses, such as bank statements and account or brokerage statements, sometimes using apps like Plaid
- Photo identification
- Credit history
- Information about any co-signers, if applicable
Steps In The Loan Origination Process
There are different steps in this process, each with specific requirements the borrower must follow. The process begins with pre-approval before moving on to the application process.
The loan origination process begins when a borrower applies for a loan.
The application process involves the applicant completing a form. With the information provided in the application, a lender vets your information to determine if you're a good candidate.
The Pre-Approval Process
While a pre-approval is not the same as an approval (the lender committing to your loan), it indicates the likelihood that your application will be successful.
Most lenders issue pre-approvals right after applicants complete the application.
If you are pre-approved, the lender will ask you to share more information and file specific documentation.
Credit departments will review your submission for its accuracy, completeness, and authenticity.
If you still need to complete all the required steps in the application, the credit department will return the application or contact you to receive additional information.
A Loan Origination System (LOS) helps determine your creditworthiness during this stage. This software streamlines application processing by automatically identifying missing information on your application.
In this stage, lenders will typically require numerous documents, such as:
- Your most recent pay stubs
- Tax returns and W-2s from the last two years of your income; if you are self-employed, the borrower will request business records, including profit and loss statements
- Up-to-date bank account statements
- Investment information
- Identification, such as your passport or driver's license
These documents are necessary to help the lender decide whether you are suitable for a loan approval while estimating how much you can afford and how much you will actually receive.
During this step, the lender determines whether your current financial situation meets their underwriting requirements by thoroughly reviewing your financial documents and information.
This will help them decide whether or not to approve your loan request.
The lender will consider the following factors during the underwriting process:
- Your credit score
- Credit risk scores
- Business or industry-specific scoring criteria
Vetting your finances will include the following:
- Considering any outstanding debts that you owe, including student loans or credit card debt
- Your prior work history and current income
- Your financial assets, including bank accounts, retirement funds, and stocks, if applicable
- The down payment amount you intend to pay and the source of your down payment (if applicable)
- What you intend to use the money for
Quality Check And Credit Decision
During the quality check stage, the lender will send your application to a quality control team, who will thoroughly review factors in your application against specific internal and external criteria.
If everything is in order, your application will move to the final step of loan origination.
The lender will make a credit decision and determine whether to approve, reject, or return your application if additional information is necessary.
If your application does not meet specific criteria, the parameters of your loan may change. For instance, you may encounter reduced loan amounts or varying interest rates.
Finally, once approved, your loan application will move on to the funding process, and all parties will sign the required documents.
Depending on the type of loan you applied for, the funding process may take a more extended period.
What Are Average Loan Origination Costs?
These costs or fees refer to all fees associated with the processing of an application, the underwriting, and the funding of the loan.
An average loan origination fee is typically 0.5% to 10% of the total loan value depending on the type of loan. For example, mortgages
usually have lower origination costs than commercial loans.
The origination fee can fluctuate depending on the required amount and other factors such as the credit score.
How do lenders determine the price of the loan?
When it comes to determining the price of a loan, lenders utilize a variety of approaches. Risk-based pricing is one way to evaluate and assign costs.
This approach considers the borrower's creditworthiness before granting the loan by reviewing credit history, income levels, outstanding debt, and other elements.
The higher risk an individual presents or asks for in terms of rate/term features - typically resulting from subprime or near-prime scores - will directly influence interest rates and fees associated with that loan product.
Relationship-based pricing is another method used; with this approach, individuals with deep ties to the financial institution can expect lower rates as there is a less perceived risk due to established trust between both parties.
Other factors include the customer relationship length and activity level within their accounts.
This builds a greater understanding between lender and borrower, often extending favorable interest rates throughout all facets of their financial relationship (credit cards, investments, etc.).
Loan Origination vs. Loan Servicing
While loan origination occurs when a borrower first applies for a loan, servicing commences once the lender completes the origination process.
What is Loan Servicing?
Loan servicing involves the ongoing process of a lender collecting the borrower's payments and distributing these payments to the correct parties.
These parties include investors, insurers, tax authorities, and anyone involved in the process. During the loan servicing process, the following occurs:
- The lender distributes the funds accurately and on time
- The servicer maintains a relationship with the borrower to address any issues or obstacles
- Then, the servicer contacts the borrower if you missed a payment
- The servicer helps the borrower end the loan agreement if they cannot pay their loan
- Loan servicing is ongoing and only completed once you pay off the loan
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What is a loan originator?
A loan originator is a financial professional who assists in the origination of loans for individuals or businesses. In other words, they help create and facilitate the process of obtaining credit by guiding borrowers through all necessary steps.
What is a loan origination system?
A loan origination system (LOS) is an end-to-end automation platform used to manage the entire process of originating, approving, and servicing a loan.
It simplifies and streamlines many tasks associated with the loan process, from application to closure and service.
What is the difference between origination and underwriting?
Origination is the process by which the lender receives and evaluates the loan requests, while underwriting is an evaluation of potential risks associated with a loan.
Origination occurs when a borrower submits a loan application to a financial institution or lender, who then reviews the application and verifies that the borrower is eligible for the requested loan.
Underwriting is part of the origination process. During underwriting, lenders review financial records to ensure borrowers can repay their loans.
What is fraudulent loan origination?
Fraudulent loan origination is the practice of obtaining a loan by providing false or inaccurate information to lenders.
This can include misrepresenting one's credit history, income, assets, and liabilities to qualify for a larger loan or get a lower interest rate.
What are loan origination costs?
These costs refer to all fees associated with the origination and processing of a loan. They are also known as loan setup fees, closing costs, or points.
The average cost of a loan origination fee varies depending on the type and amount of loan taken out and other factors such as credit score.
What does lender processing mean?
Lender processing occurs during this step when the lender decides whether your application can move forward toward approval.