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.

Commitment Fee vs. Facility Fee

A facility fee is a charge paid by a borrower to a lender or financial institution for the provision of a credit facility (such as a loan or line of credit), whether or not the borrower uses the facility. Conversely, a commitment fee is the amount charged by a lender to keep a specific loan amount available to a borrower. This means that there are several differences between the concepts, which are as follows:

Basis of the charge. A commitment fee is based on the unused portion of a loan, while a facility fee is based on the entire lending facility, whether it is used or not.
Purpose of the fee. A commitment fee compensates the lender for reserving funds for potential use, while a facility fee compensates the lender for setting up the facility.
Timing of the fee. A commitment fee is charged on an ongoing periodic basis, while a facility fee is charged up front.
Funding to which the fee is applied. A commitment fee is only charged on the unused portion of a line of credit, while a facility fee is applied to the entire line of credit.