Commitment letters are formal and legally binding documents that are issued by a lender to a loan applicant. The text of the commitment lender contains an offer to extend a loan to the applicant. Within the content of the letter, the exact terms and conditions involved with the loan commitment are specified.
The main purpose of the commitment letter is to inform the borrower that the loan has been approved, as long as certain conditions are met. Known as an Offer of Advance in some parts of the world, the letter in a sense serves as a cover letter to the actual contract that will be signed by both the lender and the borrower. While the format may vary slightly, most lenders prefer to include the commitment letter along with the formal agreement.
Within the text of the letter, the lender will include specifics that are important for the applicant to study closely. The total amount of the loan is included, along with a breakdown of the interest rate that will be applied. Often, the number of installment payments is noted, along with the amount of each installment. The commitment letter may also touch on such matters as any penalties that apply if the loan is paid off in advance, or actions that the lender may take if the loan falls into arrears for some reason.
Receiving a commitment letter does not place the applicant under any obligation to pursue the loan through that particular lender. In the event that the applicant has approached several different lending institutions, it is possible that he or she may receive commitment letters reflecting several different loan commitments. When this is the case, the applicant can simply notify the issuing institution that he or she has chosen to accept the loan offer of another lender. Generally, this should be done with a formal reply. The borrower should also return the commitment letter and any enclosed paperwork at the same time.