What it means
Exit fees appear across lending, funds, pensions and commercial contracts, and they all do the same job: they compensate the other side for income it loses when you leave. A lender pricing a five year loan expects five years of interest, so ending the arrangement after two upsets the arithmetic it based the rate on.
In lending the fee is typically 1% to 5% of the outstanding balance, sometimes tapering each year until it disappears. Bridging and development finance almost always carry one, because those lenders earn much of their return through fees rather than through the interest rate itself.
Funds use exit fees, sometimes called redemption charges or contingent deferred sales charges, to discourage short term money. If investors can arrive and leave at will, the manager is forced to hold extra cash or sell assets at bad moments, which damages returns for everyone still invested.
The fee is not automatically bad value. A loan at 6% with a 2% exit fee can be cheaper overall than one at 8% with no exit fee, provided you have a realistic view of how long you intend to keep the facility.
The practical rule is to convert every charge into a single number before comparing offers. Add the arrangement fee, the interest over the period you actually expect to borrow and the exit fee, then express the total as a percentage of the amount borrowed.
In practice
Real-world examples.
Example
A property developer takes a $3,000,000 bridging loan carrying a 1% exit fee and pays $30,000 on the day the sale completes. Because the loan runs for only seven months, that fee is a much larger share of the total cost than the quoted interest rate suggests.
Example
A retail investor moves $250,000 out of a managed fund after fourteen months and is charged a 1.5% redemption fee of $3,750, because the fund waives the charge only once money has been invested for two full years.
Example
A manufacturer ends a five year software contract in year three and pays an exit fee equal to half the remaining subscription value, $180,000 on $360,000 of unbilled commitment, in order to move to a competitor.
Formula
Calculation
Exit fee = outstanding balance x exit fee rate
Net benefit of leaving = savings over the remaining term - exit fee
A business has a $2,000,000 loan with three years left to run and $1,600,000 still outstanding. The exit fee is 2% of the balance, so leaving costs $1,600,000 x 0.02 = $32,000.
A new lender offers a rate 1.5 percentage points lower, worth $1,600,000 x 0.015 = $24,000 a year, or $24,000 x 3 = $72,000 across the remaining three years. The net benefit of refinancing is therefore $72,000 - $32,000 = $40,000, so the move is worth making, although a remaining term of one year rather than three would have flipped the answer to an $8,000 loss.Case study
Seen in the real world.
The following is an illustrative and entirely fictional example. Brindle Wharf Developments, an invented residential builder, borrowed $4,000,000 for ten months to finish a warehouse conversion. The headline rate looked reasonable at 9%, and the finance director compared it favourably against a bank facility quoted at 11%.
What the comparison missed was the fee structure. Interest across ten months came to $4,000,000 x 9% x 10/12 = $300,000, the arrangement fee added 1.5% or $60,000, and the exit fee added a further 2% or $80,000, bringing the total cost to $440,000.
Expressed properly, $440,000 on $4,000,000 is 11% for ten months, which annualises to 11% x 12/10 = 13.2%, well above the bank quote the fictional team had rejected. The lesson in this invented case is that an exit fee on a short facility is spread over very few months, so its effect on the true cost of money is far larger than the percentage on the page implies.
Watch out
Common mistakes.
- Comparing loans on the interest rate alone and treating the exit fee as a detail to worry about nearer the time.
- Assuming an exit fee is charged on the original loan amount, when most are calculated on the balance outstanding at the moment you leave.
- Forgetting that exit fees on short facilities have a disproportionate effect, because the cost is spread over months rather than years.
Questions
People also ask.
Is an exit fee the same as an early repayment charge?
They overlap heavily, but an early repayment charge applies only when you repay ahead of schedule, whereas some exit fees fall due however the facility ends.
Can exit fees be negotiated?
Often yes, particularly in commercial lending, where a borrower with a strong track record can have the fee reduced, tapered or removed in exchange for a slightly higher rate.
Do exit fees have to be disclosed?
Regulated consumer products require clear disclosure of all charges, but commercial and unregulated agreements rely on you reading the schedule of fees attached to the contract.
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