The loan commitment letter is one of the more important documents in the mountains of paper that a property transfer will originate. Many people are unsure of where a loan commitment letter fits into the process, and most importantly, if the letter is the legally binding. Here are the basics about the loan commitment letter and what it means for you from a legal standpoint.
What is the loan commitment letter?
The loan commitment letter is a letter from the lender to the borrower. It occurs after the preapproval process and an underwriter review, and includes all of the conditions that the lender requires to continue forward with the loan.
Is the loan commitment letter a legally binding commitment?
Although the letter is a cultural and ethical commitment, nothing is a done deal in real estate unless the money is in your hand. There are always conditions in the letters, and the bank has the right to pull the rug out from under you right up until the closing table discussion. Although banks will not do this unless something concrete changes your financial situation, there are things that you need to be aware of that can affect your standing.
If your lender has you sign a Compliance Agreement after giving you a loan commitment letter, you should be incredibly careful not to let your financial situation change between now and closing. The Compliance Agreement letter is your agreement that you will continue to assist the lender in verifying your financial standing until they are satisfied with it. This means that the lender may check your credit on the day before closing and pull the rug out from under you if you have a new credit line open or you purchased a large asset.
What red flags should I stay away from in order to make my lender commit?
You should not set up cable, Internet, or security services before closing on your house. These three services specifically will want to pull your credit before they finalize the hook up to your house. If your lender sees that your credit has been pulled before the closing, it will likely go back into your financial standing and reassess, even if you have not spent any more money. Many borrowers are unaware that every time your credit is pulled, it has a slight negative effect on your credit score. This is enough for a lender to pull the plug even after the loan commitment letter has been given to you.
Of course you should stay away from the purchase of any large assets such as cars or furniture. It does not matter if the furniture is for the house that you are trying to close on; many bankers simply do not have a choice in the matter. If the computer says that your financial standing is no longer adequate, the banker may be forced to close the loan. Do not open any new lines of credit even if you do not spend any money on those credit lines. Just having a new line of credit can affect the metrics that your lender is using to assess your financial standing.
Do I have any legal standing if a lender pulls the plug after the loan commitment letter?
Your lender always has the upper hand in terms of legal standing because of its financial standing. Depending on the culture and the laws of the municipality that you are in, you may have an argument in court if a lender chooses to take funds away from you after issuing a loan commitment letter. However, the time and financial resources that it would take to fight this case usually is not worth it, especially if you are trying to conserve your resources for down payments, closing costs, and other fees. Your lender knows this, and you really should not go into a negotiation looking to fight someone who is trying to give you money in the first place. The best strategy is compliance with your lender and having a backup lender ready to go if the primary lender fails to come through for you.
One of the biggest mistakes that homebuyers make is filling out an application with only one lender. 75 percent of potential homebuyers only fill out one loan application and receive one loan commitment letter. If you want to protect yourself from the risk that your lender may pull away from the deal, have more than one lender ready. This means more preapproval negotiations and red tape, but the process is always worth it.
Is there a difference between preapproval and the loan commitment letter?
Another mistake that many borrowers make is confusing the preapproval process with the loan commitment letter. Loan commitment comes after preapproval, and only after the preapproval has been vetted again by the underwriter. Although you can go into negotiation with the seller after the preapproval, only the loan commitment will allow you to close on the property.
Are there any other precautions that I can take?
Make sure that you are doing business with a reputable lender before you get too deep into the process. You also have a much better chance of a true commitment from a smaller, local credit union then you do with a large bank. Large banks have a larger volume of business, and as such, they have much less of a personal connection to your individual negotiation.
2 Point Highlight
The Compliance Agreement letter is your agreement that you will continue to assist the lender in verifying your financial standing until they are satisfied with it.
If your lender sees that your credit has been pulled before the closing, it will likely go back into your financial standing and reassess, even if you have not spent any more money.
