What is a Loan Commitment?

Taking out a loan can never be easy. There are so many complicated terms involved, you might even consider not borrowing at all.

However, it does not always have to be like this. The entire process of borrowing can be made easy with just a little research. Once you know what everything is and what you need to do in order to get the best loan agreement policy.

One of these so called complicated terms is a loan commitment. Let’s look at what exactly it means.

What is a Loan Commitment?

A loan commitment signifies the lender’s promise to offer a loan to a borrower.

What is a Loan Commitment Letter?

Loan commitment or a loan commitment letter is a formal letter sent from a lender which states that the applicant has qualified for the loan. This also confirms that the lender has promised a specific amount of money to the borrower. It also includes all the terms and conditions of the loan. You can check a loan commitment letter sample to get a basic idea of what it holds.

Since many loan commitments are usually open ended which means the loans are not only a one-time lump sum payment that the borrower has to pay back but instead, the borrower can choose to use this amount for as long as they want as long as they keep paying it back. This feature makes it similar to a revolving line of credit such as a credit card. If a portion of the loan amount is used and paid back by the borrower, the lender will apply the payment to the borrower’s principal balance.

An open ended loan commitment is usually contingent on the borrower’s credit status. It also requires the borrower to meet certain qualifications in order to get a loan.

A loan commitment can either be a secured loan which requires collateral or an unsecured one which does not require any collateral or an unfunded loan commitment.

Loan Commitment Example

A borrower applies for a mortgage and receives many notices throughout the process that let them know about the status of the loan including how everything works. The first thing they receive is a prequalification letter confirming that he meets the loan requirements. However, the lender would still have to review their documentation before a final decision is made.

Once the lender has received and successfully reviewed all documentation, they will send a loan commitment letter to the borrower confirming the decision. This loan commitment letter will include the amount decided for the loan and the terms and conditions of the loan such as the interest rate and the term.

Loan commitments can come in different types and can vary depending on the type of loan it is. The few types of loan commitments are listed below:

1. Revolving secured loans include a home equity line of credit (HELOC). Once you are approved for a HELOC, you can have a certain maximum loan amount. However, as long as you keep making the loan payments, you are free to use the principal to pay it off and use the loan again. But it is important to keep in mind that for this kind of loan, your home is kept as collateral.
2. Revolving unsecured loans include the example of a  credit card loan. You are likely to have a credit limit on your credit card. And when you make a purchase on your credit card or draw down part of the credit card limit, you may choose to use it again after you have paid it off if that is what you need. There will be no collateral associated with your credit card.
3. Non-revolving secured loans include an example of a mortgage on your home. It does require collateral which is your home. However, when the home has been paid off, the amount is closed. The first mortgage you take out on the home is a non-revolving secured loan. Besides a mortgage, another example that you can use is your automobile loan.
4. A non-revolving unsecured loan includes the example of a personal loan that you might take out from a commercial bank. It can be for any reason such as card consolidation. However, if your credit card balances get too much to handle, you may be able to consolidate them by using a personal loan. Another example for a non-revolving unsecured loan is a student loan.

How to Get Loan Commitment

You can get a loan commitment letter for any of these loans. However, the first thing you need to do is review your credit history. In case there are any errors, you should fix them immediately. The best way to do this would be to get copies of your credit history from the three major credit bureaus that you can each review. In order to get a loan commitment letter for any of these loans, you need to have a spotless credit history as well as a high credit score.

Before filling out the application for the loan that you want, you should compare similar loans for the best interest rate and terms. You should compare these loans from at least three different lending institutions in order to get an effective comparison.

However, for a student loan, most universities have online applications and if not, they direct you to the appropriate website where you could apply for one. It is necessary for you to apply for student loans before the term you will be starting school. If possible, make sure it is far in advance.

Advantages and Disadvantages of Loan Commitment

Open end loan commitments are typically flexible and can be used to pay any unexpected short-term debt obligations. They can also be used to cover financial emergencies.

Additionally, HELOCs also tend to have low interest rates which help make their payments more affordable. Moreover, secured credit cards help consumers rebuild or establish their credit. They pay their bill on time and keep total credit card debt low to improve their credit scores. With this strategy, they may be eligible for an unsecured credit card in time.

However, the downside of a secured loan commitment is that borrowers may have to forfeit their collateral, which is often their home, if they take out too much money and are no longer able to repay the loan. This would mean they can end up losing their home and the place they live in, making it a high stakes decision and very risky. Unsecured commitments also have a higher interest rate which means borrowing will be made more expensive.

The Bottom Line

So now that you have an answer to the question, “what is a loan commitment?”, you can make sure that the loan commitments you are going for is the best option for you.

Now if you take good care of your finances and take all appropriate measures as well as go through the necessary steps, you can easily be a recipient of a loan commitment letter.