Loan commitment

What it means

A loan commitment is a bank's undertaking to lend a client up to a certain amount on agreed terms if the client asks within a set period. The bank thus confirms in advance that financing will be available, even though no money has yet been lent and the client may never use it.

A commitment may be non-binding, merely a preliminary expression of the bank's willingness, or binding, where the bank undertakes to lend once conditions are met. A binding commitment is preceded by a thorough assessment of the client's creditworthiness and the project, as for the loan itself.

It is used mainly in tenders and public procurement, where the contracting party wants assurance that the bidder can finance the contract, in property purchases where the seller asks for proof of financing, and when planning larger investments.

How it works in practice

In public procurement, the contracting authority may require a bank's confirmation of a loan commitment as evidence of financial standing. The company should request it in good time, since the bank needs time to assess the case and issue a document with the right wording.

Banks often charge a fee for a binding commitment, or a commitment fee on the undrawn portion of the loan. For the company this is a cost to be built into its pricing, especially when bidding in several tenders it may not win and where it may never draw the loan.

A loan commitment differs from a bank guarantee. A guarantee protects a third party in case the client fails to meet an obligation, while a commitment only confirms that financing is available. Tenders often require both documents for different purposes.

What to watch out for

A commitment is usually conditional, for example on providing further documents, the company's financial position remaining stable or the loan being secured. If conditions change or are not met, the bank may decline to lend, so it is important to read carefully under what circumstances the commitment applies.

A commitment has limited validity. If the choice of supplier, the property purchase or the investment is delayed, the commitment may expire, and renewing it may mean a fresh assessment and different terms, especially if market interest rates have changed.