A Loan Commitment Letter, also known as a Mortgage Commitment Letter or Mortgage Loan Commitment Letter is a written and signed document from the lender or mortgage company that states the listed borrowers have been approved for the loan by an underwriter.
That’s the short version.
There is a lot more to know about a commitment letter, including what it contains, why it’s important, and whether or not it is legally binding.
A commitment letter is issued by a lender, typically a bank or mortgage company, when the underwriting department feels they have fulfilled their due diligence and that the borrower(s) have passed strict qualification requirements for their loan to be funded at closing.
The loan commitment letter will typically include:
- Commitment Date
- Loan Amount
- Type of Loan
- Interest Rate
- APR (Annual Percentage Rate)
- Closing Costs
- Total Payment
- Expiration Date
The expiration date provides a window of time in which the real estate closing must occur. If closing does not take place by the expiration date, the lender may choose to give an extension or may require additional due diligence (such as updated bank statements or a new appraisal) depending on the duration of the delay.
Another important section of the mortgage loan commitment letter is the list of conditions. While not all letters have conditions, most will and it’s important for both buyers and the sellers to understand them.
Conditions of the Loan
A loan commitment letter will likely include a list of contingencies. These are actions or circumstances that would prevent the lender from funding the loan. Typical conditions include changes in the buyer’s credit, financial, and/or employment status that would negatively impact the buyer’s ability to repay the loan.
Other common conditions include damage to the home being purchased or a low appraisal. If the home being purchased does not appraise at or above the purchase amount in the real estate contract, the lender may require a renegotiation of the price, additional money down, or may completely cancel the loan.
Sellers may want to be cautious of any commitment letters that include conditions that indicate the buyer is not yet fully qualified such as “pending income verification” or “pending further credit review”. These may be signs of a weak commitment and may signal that there are still qualification barriers that need to be resolved prior to closing.
Is a Loan Commitment Letter Binding?
A questions that is often asked is “are commitment letters legally binding”. The answer is both yes and no and depends a lot on how the letter is written. Lenders often include conditions that would allow them to step away from the loan, but simultaneously obligate the borrower to move forward with the loan as long as the all the terms listed in the letter are met. This means that while the lender can still back out, some letters prevent borrowers from declining the loan.
Why would a borrower want to decline a loan? A borrower may have found a loan with a different lender with more favorable terms. An interest rate that is even a quarter of a percentage lower can result in thousands of dollars in savings over the life of a loan. However, if the borrower has already signed a commitment letter, they may be obligated to stick with the loan with the higher rate. Borrowers that are still shopping for the best loan should not rush to sign a commitment letter that carries an obligation clause or hefty fees for cancelling the loan process.
Ideally, borrowers and lenders are on the same page when they execute a mortgage loan commitment letter. The buyer (borrower) is committed to the loan and will follow all qualification guidelines while the lender will have fully completed due diligence and is ready to fund the loan for closing. This is the true intent of the commitment letter and gives all parties the most reassurance that the closing will take place on time and in according to the expected terms.