What Does Commitment Letter Mean?
A commitment letter is a formal, legal and binding document that is issued to a loan applicant by a lender. The letter's content states that the lender is going to extend a loan to the applicant and what the precise terms and conditions of the loan are including the rate of interest.
Divestopedia Explains Commitment Letter
The objective of the commitment letter is to let the applicant know that his or her application for a loan has been successfully processed and cash is available to the applicant. At the same time, this availability is based on certain terms and conditions and the loan will be revoked if these terms are not upheld. Sometimes, it can also specify the amount of money that the bank is willing to offer, which could be less than what the applicant asked for. For example, if the applicant has requested a loan for $1 million and the bank is only able to offer $800,000 based on the credit standing and value of collateral, then this would be communicated to the applicant. Also, the rate of interest and terms of repayment are mentioned explicitly in the letter. Sometimes the penalty for non-payment and the interest charged for non-payment and other actions that may be initiated by the bank, are also explained. In other words, it is a formal record of what the lender can offer and it is up to the applicant to decide whether to take up the offer or not. In this sense, the commitment letter is not the loan contract itself, rather it is a cover letter to the loan agreement that will eventually be signed by both parties if the terms are agreeable.
Getting a commitment letter does not put the applicant under any pressure to accept the loan. In fact, an applicant may approach different banks to get the best lending terms. Therefore, it is possible for a person to have multiple commitment letters from several different institutions. In such a case, the applicant is most likely to take the best offer and the other institutions should be informed of the decision, though it is not necessary to give specific details as to which lender was finally chosen.