What is a 'Commitment Fee'

A commitment fee is a banking term used to describe a fee charged by a lender to a borrower to compensate the lender for its commitment to lend. Commitment fees are typically associated with unused credit lines or undisbursed loans. The lender is compensated for providing access to a potential loan through a commitment fee since it has set aside the funds for the borrower and cannot yet charge interest.

BREAKING DOWN 'Commitment Fee'

A commitment fee is generally specified as either a flat fee or a fixed percentage of the undisbursed loan amount. The lender charges a commitment fee as compensation for keeping a line of credit open or to guarantee a loan at a specific date in the future. The borrower pays the fee in return for the assurance the lender will supply the loan funds at the specified future date and at the contracted interest rate, regardless of conditions in the financial and credit markets.

Legal Qualification of a Commitment Fee

Legally, a commitment fee is different from interest although the two are often confused. The key distinction between the two is that a commitment fee is calculated on the undisbursed loan amount while interest charges are calculated by applying an interest rate on the amount of the loan that has been disbursed and not yet repaid.

Interest is also charged, and paid, periodically. A commitment fee, on the other hand, is often paid as a one-time fee at the closing of the financing transaction. A further commitment fee may be charged by a lender at the renewal of credit facilities. In the case of open lines of credit, a periodical commitment fee may be charged on the unused portion of the available funds.

In most cases, if the borrower decides not to move forward with the loan, the commitment fee is still payable to the lender.

Calculating a Commitment Fee

In the case of a one-time loan, the commitment fee is negotiated between the lender and the borrower. The fee can be a flat amount, such as $1,000, or a percentage of the loan amount, such as 1%.

For an open line of credit, a formula is used to calculate the average available amount of credit on a periodical basis, often quarterly. The fee is then calculated by multiplying the average unused commitment by the agreed-upon commitment fee rate and again by the number of days in the reference period.

RELATED TERMS
  1. Utilization Fee

    An annual fee assessed by a lender against a borrower. The fee ...
  2. Origination Fee

    An up-front fee charged by a lender for processing a new loan ...
  3. Loan Application Fee

    A fee charged to process an application for a loan, such as a ...
  4. Loan Commitment

    A loan amount that may be drawn down, or is due to be contractually ...
  5. Finance Charge

    A fee charged for the use of credit or the extension of existing ...
  6. Stock Loan Fee

    A fee charged by a brokerage firm to a client for borrowing shares. ...
Related Articles
  1. Personal Finance

    Mortgage Fees That Can Trash Your Refinance Deal

    Before deciding that refinancing your mortgage at a lower interest rate is a good deal, factor all the fees into your calculations.
  2. Personal Finance

    How to Pick the Right Lender When Refinancing a Mortgage

    Refinancing your mortgage has never been easier with the range of lenders and access to information that are available to you.
  3. Small Business

    Small Business Loan Vs Line of Credit: How They Differ

    Understand the differences between a small business loan and a line of credit, and learn some of the most appropriate uses for each form of financing.
  4. Personal Finance

    How To Negotiate Your Closing Costs

    Closing costs can't be avoided altogether, but you can lower them. While there are a lot of fixed costs, there are also variable ones you can save on.
  5. Personal Finance

    Watch Out For "Junk" Mortgage Fees

    So many fees are tacked on to a mortgage, that it's easy to pay more than you have to.
  6. Financial Advisor

    Are Fees Eating Up Your Nest Egg?

    You may not be able to avoid all fees associated with retirement planning, but you should know what you’re being charged for. Here's a list of common fees.
  7. Personal Finance

    How Do Mortgage Lenders Get Paid and Make Money?

    When homebuyers educate themselves on how mortgage lenders get paid and make money, they are more likely to save thousands of dollars on their mortgages.
  8. Retirement

    Are Fees Depleting Your Retirement Savings?  

    Each retirement account will have a fee associated with it. The key is to lower these fees as much as possible to maximize your return.
  9. Investing

    A Guide To Investor Fees

    Fees are one of the most important determinants of investment performance and something that every investor should know.
  10. Insights

    Simple Interest

    Simple interest is a quick method of calculating the interest charged on a loan. Simple interest is determined by multiplying the interest rate by the principal by the number of periods.
RELATED FAQS
  1. When is an underwriting fee too high on a commercial loan?

    Learn about underwriting fees and when they're too high. If the underwriting fee exceeds 2% of the total loan size, the fee ... Read Answer >>
  2. What kinds of fees are involved in futures trading?

    Learn what the various costs are that are charged by brokerage firms and trading exchanges to individual futures trading ... Read Answer >>
  3. Where do I look for fees that I am charged on investments? What are those fees called?

    The fees and expenses charged for investments vary. The fees usually depend on the type of investment and the investment ... Read Answer >>
  4. What are typical trust fund management fees?

    Learn about trust fund management fees, such as the annual management fee, annual expense ratio, brokerage commissions and ... Read Answer >>
Trading Center