Commitment Letters and Loan RiskBanker Resource
November 6, 2012 — 1,496 views
Commitment Letters and Loan Risk
A loan commitment can be used as a transaction, and is critical for a real estate or building construction project. The loan risk can be mitigated by several steps towards the completion of the personal or commercial loan. With the use of these lending risk techniques, commitment letters can be issued, but with measures for safety:
Advantages of Commitment Lending
1. Advantages can be gained with commitment lending. The application process for a new residential loan or a commercial construction loan will involve the originator's process. The additional members of any loan processing team will include the title company, the appraiser, the mortgage processor, two real estate agents, and the borrower. Gaining a financial and purchasing commitment, through the use of commitment letters, is frequently requested. After a loan officer or loan originator has presented the pre-approval letter for the loan, and then the underwriter decides how the bank, itself, will proceed in this matter. An advantage to using a commitment letter is the inclusion of the bank in this particular purchase transaction. If the loan documents are verified as true and appropriate for the lending agreement, then the commitment letter will allow the bank to join in on this real estate purchase and ownership.
2. Due diligence and monitoring of any lending agreement are critical. Especially with a construction lending arrangement, the due diligence is in the fore front of many of the lending transactions. The value of the property is not viable until the completion of the construction. These types of commitments by a banking system may be more of a liquidity risk, since these loans will tend to be more off-balance sheet and more of a derivative-style investment for the bank. Also, with a loan to a private party, the real estate lending probably should include several conditions, that must be met in order for the residential loan to be closed. These conditions may include the items to be provided or explained, before the final approval of the lending from the bank.
There are several reasons why a lending arrangement for a residential property can be profitable for a banking institution. Finding good and solid properties can add to the growth balance sheet of a bank. Presenting a commitment towards such a real estate purchase will allow the bank to enter into the process of ownership, for the particular property. Construction lending can have advantages, also, and add to the asset base of the financial institution.