What Is a Commitment Letter?
Taking a loan is not a very straightforward process. It requires a lot of paperwork and back and forth communication between the borrower and the lender. Before the process of lending begins, the lender requires the borrower to agree to certain terms and conditions.
Letter of commitment is an agreement that informs the buyer that he will be able to access the funds after he has met those terms and conditions even though his loan application has been processed and the credit is available. This letter includes the terms and conditions, details of the loan, type of loan, the term of the loan, additional charges that may occur, etc. The borrower has to agree to all of this to begin the loaning process. Otherwise, his or her application could get rejected by the lender.
A lot of people discuss the Letter of Intent vs Letter of Commitment. It is important to note that the Letter of Intent is more like an instrument for negotiations. A letter of commitment is more elaborate and specific when it comes to stating terms and conditions.
When Do You Need a Commitment Letter?
Each lending organization has its own terms and conditions for loan lending. Unless these organizations are fully convinced, they don’t lend the loan. It is really important for the borrower to fully understand and then agree on these terms and conditions to successfully submit their loan application.
The loan commitment letter is required to inform the borrower about the terms and conditions, loan details, other extra charges such as attorney fees, administrative procedures, etc. It is also to inform the borrower that the lender is ready to give a loan only if you agree to everything written on the agreement.
This Letter of Commitment can also be seen as an agreement signed before the main agreement of the loan. The main loan agreement is different from this letter. This letter also tells the borrower about the amount the bank can loan him or her.
Purpose of Commitment Letter
The purpose of the letter of commitment includes
- To brief the borrower about his loan application
- To inform the buyer that his loan application has been processed and credit is available for him to use
- To inform the buyer that for accessing the said credit, he has to meet certain terms and conditions, along with meeting any additional costs.It works as a proof for the borrower to acquire an asset
- It works as an assurance that a deal can be financed
Inclusions in the Letter of Commitment
The agreement must include the basic details of both the borrower and the lender. Basic details include names, phone numbers, addresses, etc. Further, the letter would have details related to the loan, such as loan type, loan amount, loan period, repayment period, interest rate, taxes, and insurance applications. It will have the details of all the effective dates.
Further, it will include all the terms and conditions of the loan. It will also include information about any additional costs, such as attorney fees, administration costs, etc. It is important to add a cancellation or termination policy in the agreement. These policies ensure that the borrower or the lender has a channel to opt-out.
How to Draft a Commitment Letter?
To obtain a Letter of Commitment, the borrower has to submit their loan application to the banks with various details such as credit history, income details, job details, loan amount needed, etc.
Banks then evaluate the application and decide how much loan they can afford and how much they can offer. Once the lender is satisfied, it initiates the process of preparing a Letter of Commitment. In this process, the borrower also has to submit his or her financial documents. If the loan is to be used as a mortgage for a purchase, a mortgage commitment letter is provided to the borrower.
It should be noted that the Letter of Commitment to the project is a little different from this. The borrower should read the letter very carefully before signing it. He or she should understand each and every aspect of it to avoid any confusion or misunderstanding.
Benefits & Drawbacks of the Commitment Letter
Both the borrower and the lender have their reasons to sign a Letter of Commitment. The letter helps both parties in different ways. A well-drafted agreement only strengthens the relationship between the lender and the borrower. Thus, a Letter of Commitment doesn’t have any drawbacks.
Here are a few pointwise benefits of signing the agreement –
- It works as proof for a third party
- It works as an assurance for the third party that the borrower is capable of paying
- For the lender, it reduces the competition
- It ensures both parties are on the same page before the loan procedure begins
- It ensures there are no misunderstandings and confusion regarding the policy and terms and conditions of the loan
- It ensures that the borrower knows about all additional costs
Key Terms/Clauses in Letter of Commitment
There is no fixed pattern that a Letter of Commitment needs to follow. Depending on the requirement of a borrower and the lender, the agreement can be customized. However, some basic content and clauses remain consistent across all Letters of Commitment. Cancellation and termination are one of the most important clauses of the agreement. The agreement also contains clauses to solve any kind of violation or breach. The terms of the agreement depend on the lender. However, all lenders give a particular date of repayment, which the borrower needs to follow.
What Happens in Case of Violation?
A Letter of Agreement, when signed by both parties, should be followed religiously. When either party commits any violation or breach, the other party is well within its right to approach the court. The agreement contains dispute resolution methods. Both parties should try fixing an issue among themselves before approaching the court.
It should be noted that a Letter of Commitment comes with an expiry date. The borrower is supposed to adhere to the timeline else the lender can cancel the loan. This is a very important piece of document that needs to be drafted with precision and care. You could require such a letter in any business situation. And if you are confused about the terms and conditions of your letter, you should take the help of an attorney.
Here is a Letter of Commitment template drafted by our expert. Please download the commitment letter sample from here.
Sample Letter of Commitment
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This agreement is made between Company and Bank on the effective date of 18th November, 2011.
Company represented by
Mr. Jack Daniels
Address: 8 Warren Street, York ME 03909
Contact number: (207) 351-3100
Bank represented by:
Mr. Timothy Smith
Address: 35 Millay Road, Camden ME 04843
Contact number: (207) 236-4404
Terms and Conditions:
- First National Bank has created the following terms and conditions as mentioned in the Commitment Letter Agreement to “JP Coleman”. According to the terms and conditions First National Bank will arrange for and underwrite the credit facilities for a maximum of US$400 million, which will be provided to “JP Coleman” (the “Company”).
- “JP Coleman” will appoint the First National Bank as the Coordinating Lead Arranger for acting exclusively as the underwriters of the mentioned “Facilities” based on the various terms and conditions set out in this Commitment Letter Agreement.
- “JP Coleman” agrees that they will not appoint any other bank or financial institution to arrange for or underwrite the Facilities mentioned in this agreement or manages the financing of the mentioned Project during the period of this agreement.
- “JP Coleman” should be willing to undertake any action to fulfill the requests of “First National Bank” or the coordinating lead arranger and assist the bank in effectively syndicating the Project Facilities mentioned in the Commitment Letter Agreement for a period of 2 years.
IN WITNESS WHEREOF, the parties “Company” and “Bank” have executed this Commitment Letter agreement as on the date set forth which is 11/18/2011 (MM/DD/YY).
SIGNED FOR AND ON BEHALF OF COMPANY BY:
SIGNED FOR AND ON BEHALF OF BANK BY: