Commitment Fee

Definition

A commitment fee is a charge that a lender requires to lock in specific terms on a loan at the time of application. This fee ensures that the terms agreed upon, such as interest rates, discount points, and loan-to-value ratios, will be honored and the funds will be available when the borrower is ready to proceed. The commitment fee is usually a percentage of the loan amount and acts as a form of insurance for the lender against market fluctuations and the borrower’s potential to back out.

Examples

Residential Mortgage Loan: Jane wishes to purchase a home and applies for a mortgage. The lender offers her a loan with a 3.5% interest rate and a requirement of 20% down payment, but includes a commitment fee of 0.75% of the loan value to secure the terms.
Commercial Property Loan: XYZ Corporation is looking to finance the purchase of a new warehouse. The lender agrees to provide a $1 million loan at a 4% interest rate, contingent on XYZ paying a commitment fee of 1% of the loan amount.
Construction Loan: A builder plans to develop a residential complex and seeks finance from a bank, which offers the loan with a set of attractive terms, coupled with a commitment fee of 1.5% to lock in these terms until the project is ready to commence.

Frequently Asked Questions (FAQs)

Why do lenders charge a commitment fee?
- Lenders charge a commitment fee to secure themselves against market interest rate fluctuations and to compensate for the pledged funds’ opportunity costs.
Is the commitment fee refundable?
- Generally, commitment fees are non-refundable. However, specific terms of refundability could be negotiated and included in the loan agreement.
How is the commitment fee calculated?
- Commitment fees are typically calculated as a percentage of the loan amount. For example, a 1% commitment fee on a $100,000 loan would amount to $1,000.
What happens if the borrower does not go through with the loan?
- If the borrower decides not to proceed with the loan, the commitment fee is generally forfeited to the lender as compensation for the commitment and effort taken.
Can the commitment fee be added to the loan amount?
- In some cases, the commitment fee may be rolled into the loan amount, effectively amortizing it over the loan’s term.

Loan-to-Value Ratio (LTV): The ratio of the loan amount to the appraised value or sale price of the property, which helps lenders assess risk.
Discount Points: Fees paid directly to the lender at closing in exchange for a reduced interest rate.
Interest Rate Lock: An agreement where the lender guarantees a specified interest rate for a certain period.
Origination Fee: A fee charged by the lender for processing a new loan application.

Online Resources

References

Federal Deposit Insurance Corporation (FDIC). “Mortgage Lending Practices.” FDIC.gov.
Consumer Financial Protection Bureau (CFPB). “Understanding Mortgage Commitment Fees.” Consumerfinance.gov.

Suggested Books for Further Studies

“The Mortgage Encyclopedia: The Authoritative Guide to Mortgage Programs, Practices, Prices, and Pitfalls, Second Edition” by Jack Guttentag.
“Real Estate Finance & Investments” by William Brueggeman and Jeffrey Fisher.
“Commercial Real Estate Lending: A Complete Guide for Lenders, Borrowers, and Developers” by Kimberly Winick and Eric Jensen.
“Mortgage Management for Dummies” by Eric Tyson.

Real Estate Basics: Commitment Fee Fundamentals Quiz

### Why do lenders charge a commitment fee? - [x] To secure themselves against market interest rate fluctuations and compensate for the opportunity costs. - [ ] To pay for property appraisal expenses. - [ ] As an incentive to reduce the interest rate. - [ ] To cover the cost of loan documentation. > **Explanation:** Lenders charge a commitment fee to protect against potential interest rate changes and to repay the opportunity cost for setting aside funds. ### Are commitment fees generally refundable? - [ ] Yes, they are fully refundable. - [x] No, they are generally non-refundable. - [ ] Partly refundable based on lender discretion. - [ ] Only refundable if specified in the loan agreement. > **Explanation:** Commitment fees are usually non-refundable because they cover the lender's risk and expenses incurred while securing the loan terms. ### What is the typical way in which a commitment fee is calculated? - [ ] As a flat fee. - [ ] Based on property value. - [x] As a percentage of the loan amount. - [ ] It's standardized across all loans. > **Explanation:** Commitment fees are typically calculated as a percentage of the loan amount, ensuring the fee aligns with the loan's size. ### Which aspect of a loan does a commitment fee help to lock in? - [ ] Loan term length - [x] Specific terms like interest rates and discount points - [ ] Type of property financed - [ ] Geographic location of the property > **Explanation:** The commitment fee helps lock in specific terms such as interest rates and discount points to prevent changes prior to loan closing. ### Can the commitment fee be included in the loan amount? - [x] Yes, in some cases, it can be rolled into the loan amount. - [ ] No, it must be paid upfront only. - [ ] Only if the loan exceeds a certain value. - [ ] Only for commercial properties. > **Explanation:** In some cases, the commitment fee can be included in the loan amount and amortized over the term of the loan. ### What happens if the borrower does not proceed with the loan? - [ ] The fee is refunded. - [x] The fee is forfeited. - [ ] It’s applied to future loan applications. - [ ] Only 50% is refunded. > **Explanation:** If the borrower decides not to proceed, the commitment fee is generally forfeited as compensation for the lender's commitment. ### What is another term closely related to a commitment fee? - [ ] Escrow account - [ ] Closing cost - [ ] Appraisal fee - [x] Origination fee > **Explanation:** An origination fee is another type of fee that a lender may charge in connection with the processing of a new loan application. ### Who typically pays the commitment fee? - [x] The borrower - [ ] The seller - [ ] The real estate agent - [ ] The insurance company > **Explanation:** The borrower typically pays the commitment fee as part of securing the loan terms. ### In a commercial real estate loan, what is the primary benefit of paying a commitment fee? - [ ] Immediate reduction in property taxes - [x] Securing favorable loan terms and interest rates - [ ] Getting a larger loan amount - [ ] Reducing closing costs > **Explanation:** The primary benefit of paying a commitment fee in a commercial real estate loan is to secure favorable loan terms and interest rates until the borrowing is finalized. ### What document outlines the commitment fee's terms and conditions? - [ ] Purchase agreement - [x] Loan commitment agreement - [ ] Title document - [ ] Property deed > **Explanation:** The loan commitment agreement outlines the commitment fee's terms and conditions.