INTEREST AND FEES IN A LOAN AGREEMENT – THE BIT EVERYONE PRETENDS TO UNDERSTAND

Loan agreements are full of big-ticket items – covenants that glare at you, security packages that groan under their own weight, and events of default with the all the charm of a wet Monday in February. But the section that actually shapes the borrower’s day-to-day reality is the interest and fees section. It’s here that the real cost of the loan reveals itself, along with the extra charges that surface depending on how you draw and use the facility.

Once you understand the building blocks, it becomes easier to navigate.

How the Interest Rate Really Works

If loan agreements came with a map, the interest-rate section would be the bit circled “Start here”. This is where the real economics sit – the numbers you’ll live with month after month.  The calculation itself is built from just two ingredients: the base rate, which mirrors the market, and the margin, which is the lender’s earning for taking the risk.

Base rate – the bit that moves even when you’re not looking

Most modern loan agreements now follow the standard framework set by the Loan Market Association (LMA) – the industry body behind the templates everyone pretends to know by heart. Under that structure, the base rate is usually an overnight risk-free rate like SONIA. Instead of being fixed at the start of the interest period, it changes daily and is then compounded. That means the interest you pay reflects how the market actually behaved, rather than a single rate someone picked at the start of the month while squinting hopefully into the distance.

A couple of details are worth keeping an eye on:

• Lookback – the agreement often uses the rate from a few days earlier (five is common). This isn’t laziness; it simply gives the agent time to calculate the interest without sprinting into the weekend.
• Floor – usually set at zero so lenders don’t wake up to the horror of negative interest nibbling away at their return.

Once that’s done, the margin is added on top.

Margin – the lender’s earnings, with a personality of its own

Once the base rate has done its daily dance, the margin is layered on top. This is the lender’s actual earnings – the part that reflects the risk they’re taking by handing over the money.

Margins tend to come in two styles:

• Fixed – steady, predictable, and frankly a relief for anyone who likes their pricing uncomplicated.
• Variable – linked to the borrower’s leverage or credit rating, so it moves up or down depending on how healthy the numbers look.

A variable margin works a little like a rolling assessment of the borrower’s fitness. If the business is performing well, the margin steps down; if the metrics start wobbling, it edges upward. It keeps the pricing honest and aligned with the borrower’s credit profile as it evolves.

When a margin change actually applies

Here’s the catch: just because the borrower’s numbers show they qualify for a lower margin doesn’t mean it magically applies.

A new margin only kicks in when:

• the borrower delivers the compliance certificate confirming the relevant ratio or rating,
• and the agent has had a chance to check it.

This prevents anyone taking the liberty of applying a cheaper rate before lenders have seen the evidence.

Fees You’ll See Along the Way

Interest is only half the story. Facilities come with a cast of supporting fees that can make just as much difference to the overall cost. They’re not there to be sneaky – just to cover the realities of running a loan – but it’s worth knowing what each one does.

Commitment fee

This is charged on the undrawn portion of the facility. It compensates lenders for keeping money available even when the borrower hasn’t taken it yet.

• It usually starts running on signing or closing.
• It reduces as commitments are drawn or cancelled.
• In a term loan, it stops once the loan is fully drawn.
• In a revolving facility, it tends to keep going for the whole life of the deal because, unlike term loans, revolvers have a habit of being drawn, repaid, and drawn again.

It’s a bit like paying someone to keep their diary clear in case you might need them.

Utilisation fee

Common in revolving credit facilities, a utilisation fee kicks in once the borrower exceeds certain usage thresholds (for example, above 33% or 66% of the available commitment).

The logic is straightforward: the more you use, the less liquidity remains, and lenders get a touch of extra compensation for that reduced breathing room.

Agency and security trustee fees

These are the flat administrative fees paid to the facility agent and security trustee – the people quietly making the whole operation work. They handle payments, notices, and the security package without drama, which is worth something.

These fees usually sit in a separate fee letter. Always make sure it’s signed and incorporated; it forms part of the commercial deal even if it lives outside the main agreement.

Default Interest

If a borrower misses a scheduled payment, they won’t be marched out of the building, but their overdue amount will start accruing default interest. This is usually the normal interest rate plus a small uplift (often 1–2%).

A couple of things to note:

• It applies only to the overdue amount, not the entire loan.
• It accrues only while the payment is outstanding.

Default interest isn’t meant to deliver a scolding. It’s simply there to encourage payments to arrive when they’re supposed to, rather than drifting fashionably late.

Break Costs

Break costs come into play when a borrower repays early during an interest period. If the lender has already funded themselves based on the original timetable, early repayment can leave them with a mismatch. Break costs bridge the gap.

• They’re straightforward in fixed-rate or hedged loans, where the lender’s own funding is locked in.
• They’re smaller – but not zero – under RFR-based loans, because the rate resets daily.

It isn’t a telling-off for being early. It’s just compensation for the funding the lender can’t magically unwind.

The Last Word

Interest and fees may not be the section anyone frames on their wall, but they’re the part that reveals the true economics of the deal. Once you understand how the base rate shifts, how the margin behaves, and how the fees fit together, the whole facility becomes far less opaque. Borrowing always comes with a price tag – the trick is knowing exactly what’s written on it.