Commitment fee definition
/What is a Commitment Fee?
A commitment fee is the amount charged by a lender to keep a specific loan amount available to a borrower . This fee may also be charged for the unused portion of a line of credit . As such, a commitment fee is essentially a form of insurance for the borrower, who is now assured of having a specific loan amount available for use when needed.
The commitment fee compensates the lender for its risk in keeping a loan available through an agreed-upon period of time (typically one year) without being able to charge interest , despite possible changes in market conditions that might otherwise have resulted in altered loan terms. The fee may also be associated with a commitment to charge a contracted interest rate , rather than the (presumably higher) market interest rate at the time the loan is actually used.
Commitment Fee Terms
The typical commitment fee begins at 0.25% of the undisbursed loan amount, and can exceed 1.0%. An alternative fee arrangement is for a fixed price to be charged. The lender may require that the fee be paid at the beginning of the prospective loan period. For a line of credit, the fee is usually charged on a periodic basis, based on the average unused balance on the line of credit. In some cases, a lender may refund a commitment fee after the associated loan has been repaid by a borrower. However, if a borrower never uses the associated debt, then the lender will retain the commitment fee.
Commitment Fee vs. Interest
There are several key differences between a commitment fee and an interest charge. First, a commitment fee is based on an undisbursed loan amount, while interest is based on the disbursed amount of the loan. And second, a commitment fee is charged once, as soon as a lender commits to provide a loan, while interest is charged periodically throughout the life of the loan.
