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COMMITMENT INTEREST

Meaning of Commitment Interest

Posted on April 11, 2021June 14, 2022 by usvsukenglish

If credit institutions provide a loan that the borrower does not use or does not use immediately, commitment interest is charged. This type of loan is common in mortgage lending.

  • If borrowers do not call up the entire loan amount immediately, banks can charge interest on the remaining amount that has not yet been paid out.
  • This can be especially costly if a new build is delayed.
  • Customers can arrange an interest-free period with their bank.

When commitment interest is due

Whether modernization or new construction – construction projects are usually lengthy and take place in different stages. Earmarked loans to finance construction projects are paid out by banks in installments based on the progress of construction. According to abbreviationfinder.org, commitment interest applies to the part of the loan that has not yet been paid out.

Loan disbursement as construction progresses

Interest-free period

In each section, construction progress can be delayed for various reasons. This ensures that a discount is due later than planned. This also extends the period in which the lender has the loan amount ready.

Consumer may agree on a period with their bank, in which the loan provides interest-free provision is. The deadlines can differ depending on the provider; three to twelve months are common. It is therefore worthwhile to calculate the amount of interest before entering into a loan agreement. The interest-free period is to be included. Then it can be decided whether it is cheaper to pay the commitment interest or whether the deadline should be extended. The extension of the period in which the provision is interest-free usually means interest surcharges . Depending on the individual case, it may even turn out that another form of financing is more lucrative for the customer.

Calculate commitment interest

Particularly in the case of delays in construction, the commitment interest can develop into a cost factor that causes nasty surprises. If the bank holds 100,000 euros at the monthly interest rate of 0.25% for four months, the commitment fee is 1,000 euros. The commitment interest is not included in the APR for the loan. In contrast to the borrowing rate, they are stated in the contract per month. This is why the actual amount of the costs cannot be overlooked at first glance.

Of course, commitment interest only accrues if it is contractually agreed. They are calculated from the end of the provision interest-free period. However, they are also due if shares have already been paid out. Banks can no longer charge interest until the entire loan amount has been paid out. Until then there are two forms of calculation:

  • chargeable commitment interest
  • non-chargeable commitment interest

In the first case, the bank calculates interest only on the part of the loan that has not yet been called. In the second case, the customer has to pay for the entire loan amount, even if the bank only holds a small portion.

Why do lenders charge commitment interest?

While a bank is providing a loan, it cannot invest that money elsewhere. She compensates for the lost profits with interest for the provision. In addition, she also has to pay interest for the procurement of the loan on the capital market. The commitment interest should also compensate for this.

Reduce commitment interest

It is not possible to have a special purpose home loan paid out all at once and thus avoid the commitment interest. This is only possible with an unrestricted loan.

  • Customers can negotiate a long free period with the bank .
  • Part of the equity can be withheld until the end of the construction period. This shortens the period in which an unclaimed loan generates interest.
  • The loan amount can shrink with special repayments, which reduces the commitment fee.

It is advantageous if the partial amounts are called up according to the planned construction progress. This includes small buffer times to be planned.

  • Finally, a comparison is also advisable when planning long-term follow-up. A slightly higher borrowing interest could be cheaper than a variant with commitment interest.

Deduction of commitment interest for tax purposes

Commitment interest can be deducted from tax. However, the following requirements must be met for this:

  1. The borrower must take out mortgage lending for a property that he does not or will not live in himself. The property must therefore be rented out after the construction project has been completed. This also applies if the client only lives in part of the property or uses it commercially.
  2. Commitment interest is only deductible in the year in which it was incurred – it cannot be claimed retrospectively.

COMMITMENT INTEREST

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