What Is in a Loan Commitment Letter?
Understand the binding offer for your loan. This guide clarifies what's stipulated in a commitment letter, defining your path to financing.
A loan commitment letter serves as a formal offer from a lender, indicating a willingness to provide financing to a borrower. It is typically issued after an initial review but before final loan closing. It outlines the specific terms and conditions under which the lender is prepared to fund the loan. The letter signifies that the loan application has undergone scrutiny and that funds are available, provided the borrower meets all stipulated requirements. It assures borrowers, especially those purchasing real estate, that financing is available, signaling financial readiness to sellers.
Core Loan Details
The loan commitment letter details the fundamental financial components. It specifies the exact loan amount the lender is prepared to provide, which may differ from the initial request. The interest rate is clearly stated, indicating whether it is a fixed rate, meaning it remains constant throughout the loan term, or an adjustable rate, which can fluctuate over time based on market conditions.
The letter also outlines the loan term, which is the duration over which the loan must be repaid, typically 15, 20, or 30 years for mortgages. An estimated monthly payment is typically included, often broken down to show the allocation toward principal, interest, property taxes, and insurance premiums. Furthermore, the document may identify the specific type of loan being offered, such as a conventional, FHA, or VA loan.
Conditions for Funding
A loan commitment letter includes various requirements that must be satisfied before the loan can be officially closed and disbursed. One common condition is a satisfactory appraisal, meaning the property’s assessed value must meet or exceed the loan amount to protect the lender’s investment. The letter often stipulates a successful final underwriting review, where the lender reviews the borrower’s financial history, credit, and employment.
Verification of income and assets is another standard condition, requiring borrowers to provide documentation such as pay stubs, W-2 forms, tax returns, and bank statements. For self-employed individuals, alternative forms of income verification, like bank statements or profit and loss statements, may be accepted. Lenders also assess credit and debt-to-income (DTI) ratios, generally preferring a DTI ratio below 36%, though some approve loans with ratios up to 43% or 50% for certain loan types. Requirements for title insurance to confirm clear ownership and hazard insurance to protect the property are also stated. Any significant change in the borrower’s financial situation, such as job loss or taking on new debt after the commitment is issued, can jeopardize the loan’s final approval.
Associated Costs and Fees
A loan commitment letter itemizes various costs and fees for which the borrower is responsible. Origination fees cover the administrative expenses of processing the loan application, including underwriting and preparing documents. These fees are commonly 0.5% to 1% of the total loan amount and can sometimes be referred to as “points.” Some lenders also charge a separate underwriting fee, which can range from $100 to $1,000.
Other expenses include appraisal fees for the property valuation and credit report fees for reviewing the borrower’s credit history. Costs for ensuring clear property ownership are also listed, such as title search and title insurance fees. Recording fees are government charges for officially documenting the loan transaction. The letter also details prepaid expenses, amounts collected at closing to cover initial costs like property taxes and homeowner’s insurance premiums, often held in an escrow account. A commitment fee, distinct from the origination fee, may be charged for guaranteeing the availability of funds, usually 0.25% to 1% of the loan amount or the unused portion of a credit line.
Acceptance and Expiration
The loan commitment letter specifies a deadline by which the borrower must accept the terms of the offer. Acceptance typically involves signing and returning the letter to the lender within a stipulated timeframe, often 7 to 10 business days. Failure to accept by the specified expiration date means the lender is no longer obligated to provide the loan under those terms. This may require the borrower to seek new financing.
Even after acceptance, the letter may contain clauses that allow the lender to withdraw the offer under specific circumstances. These circumstances often relate to significant changes in the borrower’s financial situation, such as job loss, an increase in debt, or a decline in credit score. Property-related issues, like a low appraisal that significantly undervalues the property, can also lead to a withdrawal of the commitment.