What is a Standby Fee?
Standby fee is a term used in the banking industry to refer to the amount that a borrower pays to a lender to compensate for the lender’s commitment to lend funds. The borrower compensates the lender for guaranteeing a loan at a specific date in the future. In exchange, the lender provides the assurance that it will provide the agreed loan amount at a particular date in the future at an agreed rate of interest, even if there are changes in the financial markets in the interim.
In loan agreements, the standby fee is mostly associated with unused credit lines that may be utilized by borrowers in the future. The borrower takes advantage of the lender’s line of credit in the event that are no preferred credit terms that can be accessed from lenders. If the borrower fails to close the loan within the agreed period or violates the conditions of the loan, the standby fee is forfeited in favor of the lender.
Standby Fee vs. Interest Rate in Loan Agreements
The terms “standby fee” and “interest rate” are often confused due to their similarities and their usage in servicing credit. The main difference between these two terms is in how they are computed. While a standby fee is calculated on the amount of unused credit that a borrower has with the creditor, the interest rate is calculated on the amount of credit that has been disbursed to the borrower. The interest rate of the loan may be calculated as a fixed periodic repayment or as a percentage of the loan on a reducing balance basis.
Another difference between the two terms is the repayment schedule. The standby fee is paid to the lender as a one-time fee when the lender has promised to provide credit to the borrower. The fee is paid regardless of whether the borrower takes the loan or not, as long as the lender had guaranteed to provide a loan within a specified time frame.
On the other hand, interest is charged on the amount of loan awarded and disbursed to a borrower. The interest repayments are made periodically according to the agreed interest rates and timelines, such as monthly or quarterly repayments.
Example: Standby Fee in Loan Agreements
Bank ABC requires all borrowers to pay a 0.25% standby fee on the amount of credit borrowed. Assume that Company XYZ, which deals with wine processing, wants to secure a loan of $1 million to facilitate the acquisition of Company EFG, which deals with the manufacturing of wine glasses.
Bank ABC will send a commitment letter to Company XYZ detailing the terms of the loan, the standby fee, and other fees related to the loan. If the borrower agrees with the terms of the loan, it will sign and return the commitment letter, along with a standby fee of $2,500.
Example: Standby Fee in Mortgage
In the real estate industry, mortgage lenders often assess the ability of their clients to repay the mortgage before deciding whether to advance credit. In addition to the interest charged on the mortgage, the lender may require the lender to pay a standby or commitment fee in exchange for the lender agreeing to keep the credit line open in the future. The fee may, however, be viewed differently by different lenders. Some lenders may consider the commitment fee as a general fee for loan processing, while others may see it as a charge for the underwriting process.
Another scenario where standby fee applies in real estate is when the borrower believes that interest rates are likely to rise in future when they may need to take a mortgage. The borrower may get into an agreement with the lender to lock in the current interest rate by paying a commitment fee. The agreement ensures that when the borrower takes the mortgage at a future date, the mortgage will be charged at the prevailing interest rate at the time of paying the standby fee.
The fee is combined with other closing costs that are paid by borrowers on the closing date. However, if the interest rates decline further at that future date, the borrower will still be charged at the agreed interest rate. This means that the borrower may be forced to find better mortgage terms with other lenders and forfeit the standby fee.
Standby Underwriting Commitment
When issuing stocks to the public, the company issuing the stocks and the underwriter commissioned to oversee the stock offering enter into a formal agreement referred to as a standby commitment. In the agreement, the underwriter agrees to underwrite a secondary issue of stocks to the public on certain agreed terms. The underwriter is then paid a commitment fee for its underwriting services regardless of the number of shares sold.
The commitment fee may be arranged such that an initial fee is paid at the start, followed by weekly payments during the offering period. The fee represents the minimum payment that an underwriter earns for undertaking the offering.
Sometimes, the standby underwriting agreement may provide for the payment of additional fees above the commitment fee. For example, if the underwriter guarantees to buy off the unsold shares, the issuer may agree to pay an additional fee to compensate for the underwriter’s actions. The additional fee is referred to as standby fee. The issuer requires certainty of funds, and the standby fee helps to ensure that the issuer gets all the capital it planned to collect from the issue.
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