Commitment Fee

A commitment fee is a charge levied by lenders on borrowers as compensation to keep a credit line open. This charge denotes a lender’s promise to abide by the predetermined terms of a loan, for example, interest rates and specific dates of availability, irrespective of the conditions in financial markets.

Financial institutions like banks may impose this fee on small business, commercial, and consumer loans. Moreover, revolving credit facilities’ structure may include a commitment fee as part of the loan’s terms. Typically, lenders impose a flat fee or a percentage of the future or unutilized loan amount. Usually, borrowers pay this fee after finalizing the credit agreement.

• The commitment fee meaning refers to a charge imposed by a lender on a borrower in exchange for keeping a credit line open regardless of the conditions in financial markets.
• Banks and other financial institutions levy commitment fees on mortgages and other kinds of loans, like business loans. Typically, this fee ranges from 0.25% to 1%; it varies across different lenders.
• Unlike an upfront fee, a commitment fee is a yearly fee.
• One can calculate this fee by multiplying the unused portion of a credit line by the commitment rate.   

The commitment fee definition refers to a fee that lenders like banks and other financial institutions impose on borrowers in exchange for guaranteeing future financial assistance. The lenders send a commitment letter; it states the fee the borrower must pay. Moreover, the legally binding agreement also explains how the lender determined the fee.

Typically, the commitment fee on mortgages or other types of loans ranges from 0.25% to 1%. However, lenders may impose this fee periodically if they charge it on undistributed loans. In such cases, this fee depends on the average unutilized credit line balance.

Individuals often confuse this fee with interest levied by lenders on loans. However, one must know that these two charges are different. Financial institutions impose this fee on unused or future credit. On the other hand, the lenders charge interest on the loan amount already disbursed to borrowers.

One must note that the fee and the loan agreement’s terms vary from one loan provider to another. Therefore, borrowers must refer to the loan agreement to determine whether they must pay this fee upfront.

Moreover, specific terms of the agreement indicate whether a borrower can get a refund of this fee after completing loan repayment. Indeed, in some cases, a borrower can get a refund. For instance, Virginia states that lenders must issue a refund of this fee paid by a borrower under specific circumstances. Let us look at such cases.

• When the commitment period was unreasonably short, considering the market conditions
• If a financial institution doesn’t go ahead with the loan because the value of a property against which a borrower wanted to secure financial assistance is not enough
• When a lender chooses not to go ahead with the loan owing to a borrower’s low credit score

Individuals must remember that this fee only applies to some loans. It is most common in the case of mortgage loans. This is because the duration between loan approval and closing is very long.

Individuals can utilize the following formula to compute commitment fees on mortgage loans or any other form of financial assistance:

Commitment Fee Formula = The Amount of Credit Line Unutilized x The Commitment Rate

Let us look at this commitment fee calculation example to understand the concept better.

Suppose Company XYZ availed of a loan worth $50 million from Bank ABC at an interest rate of 5% per annum and a 0.5% commitment fee to compensate the bank for its commitment to lend money. Bank ABC imposes this fee on Company XYZ every year on the unutilized portion of the credit line.

The latter utilized $30 million out of the total loan amount in the first year. Hence, individuals can compute the bank commitment fee payable by Company XYZ to Bank ABC by using the above formula.

Commitment Fee = ($50 million - $30 million) x 0.5% = $100,000

Individuals must note that the above example is a simplified calculation. Usually, lenders calculate this fee based on the product of the average unutilized credit line balance, the number of days in the period, and the free rate.

Commitment, upfront, and facility fees are fees the borrowers pay to the lenders. However, the meaning of the terms often needs to be clarified for individuals unfamiliar with the critical differences between them. Hence, knowing their distinct characteristics is vital before seeking financial assistance from financial institutions. Therefore, the table below highlights a few crucial differences, giving individuals a clear idea regarding the fees.

This article has been a guide to What is Commitment Fee. Here, we explain its formula and calculation example and compare it with upfront and facility fees. You can learn more about it from the following articles –

• Retainer Fee
• Line of Credit
• Types of Credit