Standby Fee
A fee that the borrower pays to a lender to secure a loan in the future.
What is a Standby Fee?
A standby fee is a banking term. It's a fee that the borrower pays to a lender to secure a loan in the future. The borrower pays a fee once to a lender, and in exchange, the lender guarantees a loan at a fixed date and interest rate.
A standby fee is paid to commercial banks for their legal commitment to lend funds that have yet to be transferred. The main purpose of the fees is to compensate the lender for guaranteeing a specific payment, to be received at a specific date and time, regardless of the market variations.
These fees are pretty common in real estate and commercial lending. They guarantee the customer a fixed amount of the money to be lent, or this could be a service or underwriting.
In real estate, borrowers pay a standby fee to fix the current interest rates for a future mortgage. If the loan isn't executed on a specific date or time, the standby fee is supposed to be forfeited.
Standby fees are used to secure loans for a multitude of reasons. The borrowers can take advantage of future fluctuations in interest rates by securing a rate.
This fix allows borrowers to secure a loan that could inflate any cost to the borrower more in the long run. This option is great for year-long-term loans subject to changes in interest rates, such as mortgages.
If there is an event, where the loan is not executed within a specified time, the standby fee is forfeited.
Key Takeaways
- A standby fee is a one-time payment made by a borrower to a lender to secure a future loan at a fixed date and interest rate.
- Standby fees are prevalent in personal loans and mortgages, allowing borrowers to pre-order or secure a future loan.
- Standby fees can also refer to a commitment between a company issuing public stocks and an underwriter.
- Standby fees differ from interest rates. While both impact the overall cost of a loan, they serve different purposes.
Standby Fee in Loan Agreements
There are multiple types of loans: mortgages, personal loans, student loans, and many more. The main 2 loans that use standby charges are personal loans and mortgages. Both of these loans are long-term and have the most use for standby loans compared to short-term loans.
Loan Agreements
Under loan arrangements, standby fees are associated with the available credit line the borrower may use in the future. These fees are mostly one-time payments paid by the borrower that provide them with access to a specific credit line.
Most loans are borrowed at the moment and signed a few weeks or months after deciding to take out a loan. And, the standby fees on the loans are a percentage of the loan.
Once a borrower decides to take a loan, they contact their local bank and have them send a commitment letter. The letter is used to detail the terms/conditions, fees, and standby fee of the loan.
For Example
Company ABC makes chairs. After orders increase, company ABC wants to buy new equipment to make more chairs. But before they can buy any new equipment, Company ABC needs to make room for their new future equipment.
Company ABC goes to Bank BDC to secure a future loan. Bank BDC sends a commitment letter with all the details of the loan to Company ABC. Company ABC agrees, signs the letter, and pays the SB fee.
If the loan amount applied for is $2,500,000, and the standby fee was set at 0.50% of the loan amount, then the fee would be $125,000.
Mortgage Agreements
In the context of mortgage agreements, a standby fee includes payment to secure a current interest rate for a future mortgage payment. The fees are paid by the borrower to fix the interest rate, ensuring that in the future, whenever they opt for the mortgage, they will get it at the prevailing interest rate.
Standby mortgage fees will be charged at the prevailing interest rate at the time of paying the standby fees.
It is important to note that if the interest rate declines in the future, that is when the mortgage is taken, then the borrower will be charged at the agreed-upon interest rate. This will lead the parties to seek favorable contract terms elsewhere and forfeit the standby charge.
With this in mind, borrowers can pay a standby fee to lock in an interest rate. For example, if a borrower thinks that interest rates will go up in the next few years, it would be a great decision to freeze the interest at the time of the fee.
For Example
Person A wants to buy a new house, but they need a mortgage to do so. They also fear that interest rates will rise in the next decade. An option they can take is to reserve the current interest rate for their mortgage with a standby charge.
Person A goes to Bank BCD, and they formally agree to a contract. Person A pays the fee, and Bank BCD honors the loan.
Patterns are a great place to start researching interest rates. For example, you can look at the general trend the Federal Reserve Bank of St. Louis shows in interest rates.
Standby Underwriting Commitment
A standby underwriting commitment refers to the agreement between the issuer and underwriter that the underwriter will purchase any unsold shares after the public offering for an agreed-upon fee.
This underwriting commitment provides the issuer with a safety net: The underwriter bears all the risk of unsold shares.
Underwriters can be banks, insurance companies, or even investment houses. These underwriters purchase stock from a company, take the risk, and sell it to the public. These banks have experience and can usually guarantee an IPO’s success.
Stocks, especially large companies, are in high demand. Not to mention the details and lengthy process required to make a company public; therefore, it is crucial that a large or even a small company has a successful launch and raises needed capital.
Before an underwriter presents stock to the public, they prepare the company whose stock is being publicized; they help the company finalize the amount it wishes to raise, the types of securities it wants to publish, and the terms of the sale.
The agreement dictates that the underwriter will underwrite a secondary issue for public stocks. In return, the company will pay the underwriter a fee regardless of the stocks' success.
Standby Fee vs. Interest Rate in Loan Agreements
Standby fees can be mistaken for interest on a loan. Although some aspects are similar, they have distinct features. Even though interest and standby fees are paid on loans, they are paid differently and benefit different parties.
A standby charge is paid upfront and only once. It is a percentage of the loan but will not be recurring. The fee is paid even if the borrower doesn’t exercise their secured loan.
An interest rate is a recurring payment on a loan. A percentage of the loan is calculated based on credit score, the amount loaned, downpayment, and several other factors. The average interest on a personal loan is 10% as of April 2023.
Below we discuss some of the differences between the two.
| Aspects | Standby Fees | Interest Rate |
|---|---|---|
| Definition | A fee is charged to maintain the line of credit regardless of its used or not. | These rates are a percentage of the principal amount and represent the cost of borrowing. |
| Purpose | The borrower pays the lender a fee to reserve funds for future use. | The interest charged is the compensation for the lender paid by the borrower annually, semi-annually, or quarterly. |
| Payment Timing | A one-time charge is levied on the borrower. | Paid regularly with the loan installments. |
| Calculation Method | Often a fixed percentage of the unused credit. | It is a charge on the principal amount of the loan. |
| Applicability | Applicable in the case of revolving credit facilities. | Applicable to all of the loan principal amounts. |
| Risk Management | For the lender, the standby charge provides a consistent revenue stream. | The payment risk depends upon the borrowers' risk profile. How likely are they to pay or default on the loan? |
| Legal Consideration | Legalities are subject to specific terms in the agreement. | Interest rates are regulated based on fairness and compliance. |
Both can increase the overall cost of taking a loan, and both standby charges and interest rates are different in their own right, but they shouldn’t be confused. It's important to know the difference and to know their benefits.
Standby Fee FAQs
A standby fee is based on a percentage of the possible credit. Generally, it is a percentage of the loan you’re securing.
A loan of $100,000 with a 2.5% SB fee rate would cost you $2,500 to secure.
Each bank is different, and some fees are calculated differently, but generally, these fees are calculated this way.
Absolutely not; an SB fee secures a future loan with a bank. You have no obligation to exercise this right.
Although some banks may have different procedures, the consensus is that your future loan is reserved but not required. Think of it like buying an option. You buy the ability to take out a loan in the future but are not obligated.
It all depends on what kind of loan you’re getting and for what purpose. If you’re looking for mortgages, SB fees can lock in an interest rate, which could help you save money on a long-term mortgage if interest rates rise.
Furthermore, if you need to secure a loan to buy a large asset, having a loan secured can help with negotiations.
Every loan is different and requires much time and thinking before deciding. SB fees are an option but not “the” option. They can benefit a borrower immensely, but only when used properly.
A lot of people ask why banks offer standby fees. People think allowing someone to secure a loan is an uninformed decision.
Well, it’s quite the opposite. Although yes, a secured loan and secured interest are in the borrower's interest and also benefit from the instant cash injection from the SB fee. Banks can also regulate the fee cost and which loans to offer them.
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