A loan commitment is a formal offer from a lender which provides information about a loan which the lender has agreed to provide. Lenders must treat loan commitments as outstanding liabilities, because even if the loan has not been put through, the borrower has a reasonable expectation of collecting the funds, and thus they need to be accounted for in the bookkeeping of the lender. Information about loan commitments is usually listed in a specific area of periodic financial reports so that people reviewing the reports know how much money the lender has committed to lend.
The loan commitment is a written document which has legal standing. It indicates the period for which the commitment is good, the amount of money being loaned, the interest rate, and the type of loan. The document also usually describes the purpose. For example, a loan commitment might state that a loan of $300,000 United States Dollars (USD) at 6.75% has been authorized for Jane Doe's purchase of a piece of real estate as long as the property is under contract within 120 days.
For some types of deals, people are required to show proof of financing, and a loan commitment can be an example of proof of financing. For example, a developer who is working on a project could demonstrate that he or she has a loan commitment to fund the project. Likewise, people engaged in real estate transactions can use a loan commitment to show that they are good for the amount of the loan, so that the buyer can feel comfortable proceeding with a contract.
In other deals, there may be a loan commitment contingency clause. In this case, negotiations begin before a loan commitment has been received, with an understanding that if the buyer cannot secure financing, the deal will be called off. In other cases, buyers may not invoke such a clause, which means that if they cannot get financing, they are still liable for the contract. While buyers can use this to show that they are serious, this can also get them into trouble, because the credit market fluctuates, and it is not safe to assume that it will be possible to obtain financing.
In order to receive a loan commitment, a borrower must go through the process of applying for a loan, and must provide supporting documentation. This can include proof of income, evidence of funds on deposit, and other documentation which can be used to evaluate creditworthiness.
