For instance, do you know you are required to pay a commitment fee in small business loans? What is this fee? How much can it be? Let us have a look-
1. What is the Commitment Fee?The commitment fee is a fee levied on the borrower by the lender on unused credit. It is mostly applicable in Line of Credit (LOC) or working capital loans. For instance, with LOC, the lender approves a credit limit for the business. Let us assume that the limit is Rs. 10 lakhs.
If the business only utilizes Rs. 4 lakhs from the SME loan or credit limit, it will be required to pay commitment charges on the unutilized Rs. 6 lakhs.
2. Why Do Lenders Levy Commitment Charges?This is because, once a lender approves the credit limit, it sets the funds aside for the borrower for future utilization. If the borrower only uses a part of this approved limit, the lender is not able to earn any interest on the remaining amount.
Like in the example mentioned above, the lender was not able to earn any interest on the Rs. 6 lakhs not used by the borrower.
3. How Much Can the Commitment Charges Be?The lenders set a minimum utilization limit for SME business loans such as LOC and working capital loans. The limit can vary between lenders.
Some might keep it at 40%, while others keep it at 60%. If the utilization by the borrower is less than the minimum limit, commitment charges would be applicable. In most cases, the commitment charges are 0.50% of the unused loan amount.
4. How to Know the Commitment Charges of a Lender?Once your business loan is approved, you receive a commitment letter with detailed information about the commitment charges. Alternatively, you can also talk to your lender about the same.
Also, note that some lenders ask for an upfront payment of commitment charges. In such cases, the charges paid are refunded if you use the entire approved limit.
Be an Informed BorrowerWhile SME lending can be immensely beneficial for small businesses, one should try to know as much about the loan as possible along with the associated fees and charges before making a decision. Be an informed borrower to make sure that the borrowing and repayment process is smooth and helps you achieve your business goals.
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The information contained herein is generic in nature and is meant for educational purposes only. Nothing here is to be construed as an investment or financial or taxation advice nor to be considered as an invitation or solicitation or advertisement for any financial product. Readers are advised to exercise discretion and should seek independent professional advice prior to making any investment decision in relation to any financial product. Aditya Birla Capital Group is not liable for any decision arising out of the use of this information.
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