A commitment fee is a fee that lenders charge in exchange for providing a guarantee to lend money in the future. Commitment fees may be charged on many different kinds of loans, such as consumer mortgage loans, as well as in the case of commercial mortgages or small business financing.
If you are borrowing, you may be asked to pay a commitment fee. You need to know what this fee entitles you to, how much it might be, and when—or if—you can expect it to be refunded.
Definition and Examples of Commitment Fees
Lenders charge commitment fees in exchange for processing a loan and guaranteeing the ability to borrow in the future.
The amount of the commitment fee is often equal to a percentage of the amount that will be borrowed. For example, the commitment fee might equal .25% of the principal amount of the future loan. In this case, if the loan was for $100,000, the fee would be $250.
Commitment fees on commercial loans generally range from .25% to 1% of the loaned amount.
While commitment fees are not charged on all loans, they are common on mortgage loans. That's because it takes a long time from loan approval to closing, and both parties want to ensure the loan will be granted.
Borrowers often apply for a mortgage at the beginning of the home buying process. Because that process occurs so far in advance, a borrower may want to ensure the lender will actually provide the loan when it’s finally time to close and transfer ownership of a home. With some lenders, the borrower can pay a commitment fee to obtain that guarantee.
According to an April 2021 Loan Origination Report from ICE Mortgage Technology, it takes an average of 51 days to get to the closing stage of the home buying process.
How Commitment Fees Work
Lenders typically must disclose commitment fees up front. Often, they will provide a commitment letter specifying the amount of future funding they've agreed to provide as well as the commitment fee that will be charged.
Depending on the lender, commitment fees may be paid at different points in the process. They can be paid when the borrower agrees to take the future loan; when the lender agrees to provide the funds; or at the time when the loan money is actually disbursed.
Most states impose specific regulations on commitment fees. For example, New Jersey requires that the amount of a commitment fee be "reasonably related to its purpose,” often based on a percentage of the amount of the loan.
There are also some cases where lenders will provide a refund of commitment fees. Virginia, for example, specifies circumstances in which lenders must provide a refund of commitment fees, including:
- If the commitment period was too short to be reasonable, given market conditions.
- If the lender decides not to move forward with the loan because the property intended to secure the loan doesn't appraise for enough money.
- If the lender decides not to move forward with the loan because of the applicant’s lack of creditworthiness.
Commitment Fees vs. Lock-In Fees
In some cases, lenders are willing to provide not only a commitment to lend in the future, but also a commitment to lock in a specific interest rate. That means a borrower is guaranteed to borrow at the specified interest rate for a period of time, regardless of whether prevailing interest rates go up or down in the future.
A lock-in fee, or a fee to guarantee the future loan rate, may be charged as part of a commitment fee. Or in some cases, it may account for the entire commitment fee. Be sure to review the commitment agreement ahead of time to identify all costs involved.
How Much Do Commitment Fees Cost?
Commitment fees can vary by lender and type of loan. As mentioned, the commitment fee on a commercial loan typically ranges from .25% to 1% of the amount to be borrowed in the future.
Commitment fees are generally included when the annual percentage rate (APR) of a loan is calculated. APR is a broader measure of the cost of borrowing money than the interest rate alone. It reflects both the interest rate and other costs associated with borrowing, including any fees owed.
- Commitment fees are paid by would-be borrowers to lenders in exchange for a future commitment to provide financing.
- Commitment fees are common in mortgage loans because it can take a long time for a loan to close and for the lender to provide funding that the borrower applied for.
- Many states regulate commitment fees and have various requirements on the fee’s amount and purpose.