Is a Loan Commitment a Legal Document?

A loan commitment is an agreement between a lender and a borrower that sets forth the terms and conditions of a loan The lender agrees to provide financing to the borrower up to a specified amount and for a defined period of time. While a loan commitment establishes a legal obligation for the lender, it does not constitute a final loan approval There are important nuances to understand about the legal implications of a loan commitment.

What is a Loan Commitment?

A loan commitment is a written agreement in which the lender sets forth the key terms and conditions for a loan. including

• Amount of the loan
• Interest rate
• Length of the loan term
• Required fees
• Collateral needed

The commitment letter will also outline any conditions the borrower must satisfy before the lender will provide final approval and fund the loan. These conditions may include:

• Providing additional financial documentation
• Meeting certain credit requirements
• Obtaining appraisals on real property offered as collateral
• Maintaining current employment

Once the borrower meets all the conditions, the lender will remove any contingencies and issue a clear loan commitment.

Loan commitments come in two main forms:

Firm Commitment

This is a binding pledge by the lender to provide financing as long as the borrower satisfies all the terms. The lender cannot withdraw the offer except under very limited circumstances, such as fraud or material misrepresentation by the borrower.

Conditional Commitment

The lender agrees to provide financing but reserves the right to withdraw the offer if certain conditions are not met. This gives the lender more flexibility if the borrower’s financial circumstances change.

Is a Loan Commitment Legally Binding?

In most cases, a loan commitment creates a legally binding contract between lender and borrower. However, the degree to which it can be enforced depends on whether it is a firm or conditional commitment.

Firm Commitments

Courts will generally enforce a firm loan commitment and require the lender to honor the original terms, provided the borrower has met all the required conditions. The lender cannot back out simply because interest rates changed or they decided they no longer wish to do the deal. However, firm commitments are less common, especially when financing real estate.

Conditional Commitments

These are not as strongly binding on the lender. Courts recognize that the lender specifically reserved the right to withdraw the commitment if certain conditions were not satisfied. As long as the lender acts reasonably and in good faith, they can decline to close the loan if there has been a material change in the borrower’s situation.

For example, if the borrower loses their job or their credit score drops significantly, the lender may no longer deem them qualified for the loan. The conditional nature of the commitment gives the lender some legal protection if they opt not to move forward.

When Does a Loan Commitment Expire?

Loan commitments include an expiration date, which is the date by which the loan must close. If the expiration date passes, the commitment is no longer valid and the lender is released from any obligation to provide the financing.

Expiration periods on commitments typically range from 30 to 90 days. It is important for borrowers to work diligently to satisfy any outstanding conditions so they can close before the expiration date. Otherwise, they may need to start the application process over.

Can a Borrower Be Released from a Loan Commitment?

Just as the commitment binds the lender to provide the loan, it also obligates the borrower to follow through on taking the loan. However, courts are occasionally willing to release borrowers from a loan commitment if:

• The borrower’s financial circumstances deteriorate significantly
• The lender did not act in good faith
• The commitment period was unreasonably long

Borrowers should not treat a commitment lightly, as they may be held liable for damages if they walk away without proper legal justification. But absolute enforcement against an unwilling borrower is rare.

Special Considerations for Mortgage Commitments

In real estate transactions, lenders issue a mortgage commitment letter to qualified buyers. This shows sellers that the buyer is creditworthy and their financing is lined up. However, there are some important limitations:

• Mortgage commitments are usually conditional – The lender reserves the right to withdraw financing if the property appraises for less than expected or the buyer’s job status or credit changes.

• Buyers can change lenders – Borrowers are not obligated to stick with the lender who issued the original commitment, especially if they find a better deal elsewhere.

• Sellers can usually back out – Until all documents are signed at closing, either party can refuse to complete the purchase.

So while the commitment constitutes a tentative agreement, it does not guarantee a mortgage will actually be funded. Buyers should be cautious about making a firm offer to purchase property before they have a complete loan approval without contingencies.

When Loan Commitments Make Sense

Loan commitments provide useful protection to both borrowers and lenders during the financing process.

For Borrowers

A commitment locks in loan terms like the interest rate and fees, so these cannot change even if market rates go up. Borrowers gain peace of mind knowing financing will be available so they can move forward with major purchases.

For Lenders

The commitment ensures lenders will earn interest income from the loan as long as the borrower qualifies. This allows them to hedge risks and make firm offers to potential borrowers.